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Property Tax Resources

Our members actively educate themselves and others in the areas of property taxation and valuation. Many of APTC attorneys get published in the most prestigious publications nationwide, get interviewed as matter experts and participate in panel discussions with other real estate experts. The Article section is a compilation of all their work.

Jan
30

Attorney: Owners Need to Investigate Whether Possible Tax Increases from New Tax Law can be Abated

''While Republicans and Democrats remain divided on the overhaul's benefits, there is a single undeniable fact: The sharp reduction of the corporate tax rates from 35 percent to 21 percent will be a boon for most businesses"

President Trump's Tax Cuts and Jobs Act is the first sweeping reform of the tax code in more than 30 years. Signed into law on Dec. 22, 2017, the plan drops top individual rates to 37 percent and doubles the child tax credit; it cuts income taxes, doubles the standard deduction, lessens the alternative minimum tax for individuals, and eliminates many personal exemptions, such as the state and local tax deduction, colloquially known as SALT.

While Republicans and Democrats remain divided on the overhaul's benefits, there is a single undeniable fact: The sharp reduction of the corporate tax rates from 35 percent to 21 percent will be a boon for most businesses. At the same time, employees seem to be benefiting too, with AT&T handing out $1,000 bonuses to some 200,000 workers, Fifth Third Bancorp awarding $1,000 bonuses to 75 percent of its workers, Wells Fargo raising its minimum wage by 11 percent and other companies sharing some of the increased profits with employees. Companies are showing understandable exuberance at the prospect of lower tax liability, but investments many firms are making in response to the changes may trigger increases in their property tax bills.

Some companies already are reinvesting in their own infrastructure by improving and upgrading inefficient machinery or renovating aging structures. Renovations to address functional or economic obsolescence can help to attract new tenants and, most significantly,command higher rental rates for the same space.

The real property tax systems in place for most states are based on an ad valorem (latin for "according to value") taxation method. Thus, the real estate taxes are based upon the market value of the underlying real estate. Since the amounts on tax bills are based on a property's market value, changes or additions to the real estate can affect the taxes collected by the municipality.

Generally speaking, most renovations such as new facades, windows, heating or air conditioning will not change the value or assessment on a property. The general rule is that improvements that do not change the property's footprint or use, such as a shift from industrial to retail, shouldn't affect the property tax assessment. However, an expans1on or construction that alters the layout of a property can -and usually does -result in an increased property assessment. Since realestate taxes are computed by multiplying the subject assessment by the tax rate, these changes or renovations can significantly increase the tax burden.

Tax Exemptions Available for Property Improvements

Recognizing that this dynamic could chill business expansions, many states offer a mechanism to phase-in or exempt any assessment increases. This can ease the sticker shock of a markedly higher property tax bill once construction is complete.

New York offers recourse in the form of the Business Investment Exemption described in Section 485-b of the Real Property Tax Law. If the cost of the business improvements exceeds $10,000 and the construction is complete with a certificate of occupancy issued, the Section 485-b exemption will phase-in any increase in assessment over a 10-year period. The taxpayer will see a 50 percent exemption on the increase in the first year, followed by 5 percent less of the exemption in each year thereafter. Thus, in year two there will be a 45 percent exemption, 40 percent in year three and so on.

Most other states have similar programs to encourage busmess investments and new commercialconstruction or renovations. The State of Texas has established state and local economic development programs that provide incentives for companies to invest and expand in local communities.For example, the Tax Abatement Act, codified in Chapter 312 of the tax code, exempts from realproperty taxation all or part of an increase in value due to recent construction, not to exceed 10 years. The act's stated purpose is to help cities, counties and special­ purpose districts to attract new industries, encourage the development and improvement of existing businesses and promote capital investment by easing the increased property tax burden on certain projects for a fixed period.

Not long ago, the City of Philadelphia enacted a 10-year tax abatement from realestate taxes resulting from new construction or improvements to commercial properties. Similarly,the State of Oregon offers numerous property tax abatement programs, with titles such as the Strategic Investment Program and Enterprise Zones.

Minnesota goes a step further and automatically applies some exemptions to real property via the Plat Law. The Plat Law phases-in assessment increases of bare land when it is platted for development. As long as the land is not transferred and not yet improved with a permanent structure, any increase in assessment will be exempt. Platted vacant land is subject to different phase-in provisions depending on whether it is in a metropolitan or non-metropolitan county.

Clearly, no matter where commercial real estate is located, it is prudent for a property owner to investigate whether any recent improvements, construction or renovations can qualify for property tax relief.



Jason M. Penighetti is an attorney at the Mineola, N.Y., law firm of Koeppel Martone & Leistman LLP, the New York State member of AmericanProperty Tax Counsel, the national affiliation of property tax attorneys. Contact him at JPenighetti@taxcert. com.
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Jan
05

RETAIL SUFFERS FROM EXCESSIVE TAX ASSESSMENTS Assessors attempt to ignore market realities when valuing retail property.

Retail property owners' pursuit of fair treatment in real estate taxation seems to generate a river of appeals and counter-appeals each year. What makes this ongoing melee especially perplexing and frus­trating for property owners is a sense that taxing entities will often ignore market realities and established valu­ation practices to insist upon inequi­table, inflated assessments. This tendency to forsake indus­try norms is rampant, and calls for a dose of reality. This article uses the term "real value" to describe that of­ten ignored element of true property value or genuine value of the real es­tate only, meaning the market value that buyers and sellers recognize as a product of an asset's attributes and the real-world conditions affecting it. Real value in this usage is not a legal term, but encompasses issues that real estate brokers, property owners, appraisers, lawyers and tax managers regularly discuss in retail valuation. The array of issues that affect real value or market value range from the influence of ecommerce on in-store sales to build-to-suit leases, sales of vacant space, capi­talization rates for malls of varying quality, proper ac­counting for eco­nomic or functional obsolesce and more.

All of these important and timely issues find their way into an age-old discussion of how to properly value the real estate, and only the real estate, in retail properties for property tax purposes. Although these topics may involve complex calcula­tions or judgments, buyers and sell­ers regularly use these concepts to ar­rive at mutually agreeable transaction prices, which is exactly the sort of real value that assessors should recognize for taxation. Some taxpayers may be surprised to learn that the arms-length sale of a property on the open market isn't universally accepted among taxing entities as representing that property's real or taxable value. The path to rem­edying assessors' tendency to avoid finding the real value of the real estate only is to educate tax authorities and their assessors by appealing unjust as­sessments, and by sharing the details of beneficial case law that continues to shape tax practices across the country.

Cases in Point
Tax laws vary from state to state so that the applicable principle that comes from the case decision in one region may not fit neatly in another region. Nevertheless, trends and con­cepts are always important guideposts that need to be recognized. Taxpayers who present case law from other re­gions to their local courts can begin the process of introducing the truth of real value in their market. A number of new retail property tax cases have come from the Midwest. These cases deal with issues that tax­ payers coast to coast have argued and continue to argue in the struggle to establish real value in court for retail property. ln 2016, the Indiana Tax Court heard an appeal from the Marion County tax assessor, who was unhappy with an Indiana Board of Tax Review decision that granted lowered assessments on Lafayette Square Mall for the 2006 and 2007 tax years. The assessor had origi­nally valued the property at $56.3 mil­lion for 2006, but the county's Property Tax Assessment Board of Appeal re­duced that amount by more than half. Simon Property Group, which owned the mall during the years in question, appealed to the Board of Tax Review, which further reduced the property's taxable value to $15.3 million for 2006 and $18.6 million for 2007. During the appeal, taxpayer, Simon Property Group, presented evidence of the mall's $18 million sale in late 2007. It stated it had begun to market the property for sale because it was suffering from vacancy and leasing is­sues and the property no longer fit its investment mission. The taxpayer's appraiser indepen­dently verified the sale and concluded it to be arms-length, having been ad­equately marketed and there being no relationship between buyer and seller and no special concessions for financ­ing.This scenario seems like what most of us in the tax assessment community would consider a textbook example of market-defined value. Yet the county assessor appealed the review board's conclusion to the tax court.

What is noteworthy here is that the court affirmed the tax board's conclu­sions, which were also in line with the taxpayer's evidence from a real-world transaction. The sad part about this event is that it required years of review and expense to prove that a sale in the open market reflected value. In Michigan in 2014, the Court of Appeals heard a case presented at the Michigan Tax Tribunal which con­cluded in favor of the taxpayer, Lowe's Home Centers. The case is significant because the court accepted a market­ based value as true taxable value. The taxpayer's expert testified re­garding its appraisals and indicated that they were appraising fee simple interest or the value of the property to an owner, and at the highest and best use as a retail store, valued as vacant. They distinguished between existing facilities and build-to-suit facilities, ex­plaining that the subject property is an existing facility and that the build-to­ suit market rent or sale price is based upon cost of construction, whereas the existing market sale price or rent is a function of supply and demand in the marketplace. Basing his analysis on the above fun­damental premise, the taxpayer's ap­praiser valued the property in detail. Again, what makes this case signifi­cant is that the tribunal accepted the taxpayer's argument, and the court af­firmed that decision.

Incremental Acceptance
While these principles seem univer­sal, they have been rejected in many regions of our country. Tax-assessing communities wage battles to impose excessive values based on a rejection of the actual market. As most tax systems are based in the market value concept, the only resource for these taxing juris­dictions is to distort the concept. These issues are as old as dirt, but resolution remains elusive. The lesson here for the retail prop­erty owner appealing an assessment is to advance arguments that reflect real-world conditions supported by evi­dence. The decisions in these cases and others tell us that someone is listening to those arguments, and taking heed.

​Philip Giannuario is a partner at the Montclair New Jersey, law firm Garippa, Lotz & Giannuario. the New Jersey and Eastern Pennsylvania member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. Philip Giannuario can be reached at  This email address is being protected from spambots. You need JavaScript enabled to view it.

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Jan
05

Struggling with Vacancy? You May Get a Break on Property Taxes

To determine whether your property may qualify for relief, identify the market occupancy rate for that property type and submarket.

In many states, abnormally high vacancy at commercial properties should mean a lower tax bill. Market transaction evidence essentially dictates this result: States that assess taxable value on commercial properties based on market value, as though leased at market rents, should allow a deduction from that value when the property incurs above-market vacancy and collection losses.

Would buyers pay as much for a vacant income-producing property as they would for an identical property that is fully leased at market rates? Of course not. For the same reason, in states that value the property as though leased at market rents, below-market occupancy should result in a lower property tax assessment.

To determine whether your property may qualify for relief, identify the market occupancy rate for that property type and submarket. Loan underwriting is a good source of this information because lenders underwrite property loans based on the normal, stabilized occupancy rate.

For example, in many areas lenders assume 95 percent stabilized occupancy for shopping centers. In those areas, a shopping center that is only 80 percent occupied has below-market occupancy and, therefore, is worth less than otherwise similar properties with the higher market occupancy rates.

Similarly, the prospect of the imminent departure of a major tenant reduces the price a buyer would pay, even if the property currently enjoys market occupancy. And a vacant anchor space diminishes value even when the owner continues to receive rent on the dark space. All these circumstances signal an opportunity for property tax relief.

Start the process

If any of these circumstances apply, the best first step is usually to contact the tax assessor's office and inform the appraiser responsible for valuing the subject property. Providing data about the vacancy problem may be all it takes to reduce taxable value in the next assessment.

If this fails to achieve a reduced value, consider a property tax appeal. Engaging counsel experienced with property tax matters will help the owner evaluate the merits of appeal opportunities. Counsel may also be able to give the conversation with the assessor's office a fresh try.

An appraisal may be necessary to support a property tax appeal. The property owner's counsel should help select a good appraiser who can testify, if necessary. Counsel will also instruct the appraiser on what will be needed for property tax purposes.

Deduct a vacancy shortfall

In states where below-market occupancy affects property tax valuation, the appraiser should engage in a two-step analysis. First, determine the property's stabilized value. Then estimate the amount of vacancy shortfall to deduct from the stabilized value to account for the costs, risk, effort and skill that a buyer of the property would require to bring it to stabilized occupancy.

The three components of a vacancy shortfall deduction are direct costs, indirect or opportunity costs and entrepreneurial incentive. Direct costs include tenant improvements and leasing commissions that would be required to lease up the vacant space. Indirect costs include lost rent until the space is leased, lost expense recoveries and any free rent or other concessions the new tenants would require, based on market lease terms.

Finally, the entrepreneurial incentive profit margin represents the additional deduction from the stabilized value that value-add investors require for the extra risk, skill and effort required to bring the property to stabilized occupancy. The entrepreneurial incentive profit margin can range from as little as 20 percent to over 100 percent of the vacancy shortfall costs.

Another approach to account for entrepreneurial incentive is to increase the capitalization rate used in the income approach to calculating stabilized value during the first step. That does not show the effect of the abnormal vacancy as clearly. Ideally, step one includes several valuation approaches rather than relying on the income approach alone and concludes a reconciled value as if stabilized. Then the full effect of the abnormal vacancy can be isolated in the second step of the appraisal (i.e., in the vacancy shortfall analysis).

To value property with below-market occupancy, the appraiser must understand how buyers and sellers treat such properties in actual transactions. The appraiser will need to verify comparable sales prices directly with buyers and sellers or their brokers to determine how they determined the selling price for properties that sold subject to below-market occupancy. Though each party to the transaction may differ in its analysis, both will likely have performed this two-part examination to determine the as-is selling price of the struggling property. This market evidence will bolster the subject property's tax appraisal.

Just as a buyer typically would negotiate a lower price for deferred maintenance such as a leaky roof, buyers pay less for properties struggling with vacancy issues. Typically value-add investors expect a significantly higher return to compensate them for the elevated risks of trying to create additional value. Many states appropriately recognize this in lower property tax assessments.

Michelle DeLappe and Norman J. Bruns are attorneys in the Seattle office of Garvey Schubert Barer, where they specialize in state and local taxes. Bruns is the Idaho and Washington representative of American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.  DeLappe can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..​
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Dec
30

Time for your Annual Property Tax Check

Question: What do the following have in common? A developer of a new mixed-use power center. The owner-operator of nursing homes or assisted living facilities. A national retailer with a large distribution center. A 100+ unit multifamily owner or manager. The owner of hotel chain. A high-tech manufacturer with a research and development facility. Answer: They all pay property taxes.

Whether you are a real estate investor or need real estate to house and facilitate your business operation, your real estate taxes will be one of your highest expenses, and one that you must pay even if your property is vacant or underperforming. Now is the time for your yearly check-up on your Ohio properties to determine whether the values that form the basis of your property taxes are fair.

Review your assessment

Start by reviewing the assessment on your tax bills. In Ohio, your tax valuation should reflect a reasonable sale price under typical market circumstances for the land and improvements as of the tax lien date of January 1, 2017. Verify that the information in the county records is accurate. For many Ohio counties, including Cuyahoga, much of this information will be online. Double-check building size, land size, year built, number of stories, etc.

Grounds for a change in value

The following are the most common types of evidence considered by boards of revision, which is the initial reviewing body:

Sale

One way to demonstrate value is with a recent, arm's length sale price. Generally, if a sale occurred within two years of tax lien date, did not include any non-real estate items, and was typically motivated, the price will be good evidence of the real estate value for tax purposes.

Appraisal

An appraisal can also be used to justify a change in value. Appraisal done for tax appeals must value the property as of the tax lien date. The appraiser should also be ready to testify at the hearing. Appraisals for tax appeals may have requirements that are not necessarily present for appraisals for other purposes, such as financing, so it is helpful to talk to someone familiar with the process.

Property Conditions

If there are unusual conditions, severe deferred maintenance, sudden changes in occupancy, or ongoing vacancy issues that affect the value of your real estate, that information should be brought to the attention of the board. Recent sales of properties similar to yours that support a lower value for your property may also help demonstrate that your valuation is incorrect.

Filing Deadline

The deadline to contest your assessment for properties in all Ohio counties is March 31. Because it falls on a Saturday in 2018, the deadline will be extended to April 2. The complaint form can be obtained from the county in which the property is located. The form is only one page; however, there are restrictions on who can file a complaint (i.e. what relationship they have to the property) as well as some technical requirements that may be missed by those unfamiliar with them. Generally, only one complaint can be filed per triennial period, although there are some exceptions.Once the deadline has passed for a particular tax year, the chance to contest that assessment is lost.

Procedure

After your complaint is filed, the local school district where the property is located has the opportunity to file a counter-complaint. After the period to file both complaints and counter-complaints has expired, the county board of revision will schedule a hearing. Each county board has its own rules regarding the submittal of evidence, requests for continuances, etc. At the board of revision hearing you will have the opportunity to explain why the assessment of your property is inaccurate. Boards of revision are not generally bound by the Ohio Rules of Evidence; boards are also empowered to conduct their own research. The board of revision may adopt the value you are seeking; it may make no change, or grant you are partial decrease. It may even increase the value, so it is important to consider carefully before filing a complaint.

Appealing the BOR decision

If you do not agree with the decision of the board of revision (BOR), you can appeal it to the county court of common pleas, or the Board of Tax Appeals (BTA) in Columbus. The BTA is an administrative tribunal that only hears tax related cases. Proceedings at this level are more formal than at the board of revision. Prior to September 29 of this year, a decision of the BTA could be directly appealed to the Ohio Supreme Court. Now any appeals from the Board of Tax Appeals and courts of appeals to the Ohio Supreme Court are discretionary and not as of right. The Supreme Court can decide not to hear your case. It is unclear yet the consequences of this recent legislative change, but there may be an increase in disparate treatment across the state as a result.

School district increase complaints

All Ohio taxpayers should be aware that Ohio is one of the few states (Pennsylvania is another) where school districts are enabled to file an action to get your tax valuation increased. Usually, this occurs when a recent purchase price is higher than the most recent tax assessment. Be aware of how the taxes will be prorated when you are working on a sale transaction. Depending on the timing of the sale, you may end up owing additional taxes for a period during which you did not actually own the property.

No one enjoys paying taxes, but with some research and preparation, you can make sure that your share of the real estate tax burden is fair.

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Nov
14

Oregon Law Offers Potential For Property Tax Reductions

Properties under construction and projects subject to governmental restriction can take advantage of legislative provisions the state provides.

The Portland metropolitan area is undergoing an unprecedented boom in commercial construction that extends from downtown to the suburbs and into just about every product type.Many taxpayers are preparing to pay larger tax bills, either because they are developing one of those new projects, or because they own properties that are becoming more valuable in response to growing demand for redevelopment sites. This is particularly common in developed areas where infill construction is hot.

Taxpayers in either of those positions may be missing out on significant tax savings if they are unaware of two provisions of Oregon law that could offer some respite. The Oregon legislative has carved out property tax provisions for a property under construction and for a property subject to a governmental restriction. The savvy property owner needs to know about these opportunities and comply with the statutory requirements to achieve the tax benefit.

The provisions are especially relevant to Portland's latest round of development, much of which is concentrated around infill in neighborhoods and on properties that were once used for industrial activities.

It is important to remember that Oregon law bases property taxes on the real market value of the property or the maximum assessed value under the Oregon Limits on Property Tax Rates Amendment of 1997. Also known as Measure 50, this amendment imposed restrictions on future increases in assessed values and on tax rates. Taxing entities multiply the assessed value by the tax rate to calculate the taxes owed.

The state defines "real market value" as the price an informed buyer would pay to an informed seller in an arms-length transaction. The statute goes on to state that if the property is subject to a governmental restriction as to use, "the property's real market value must reflect the effect of those restrictions."

That brings us to the tax-saving opportunities associated with usage restrictions and construction. Taxpayers typically think of government restrictions only as zoning law or a conditional land-use limitation. Often overlooked are environmental restrictions on a property's use, such as when the federal Environmental Protection Agency or the Department of Environmental Quality has identified the land as a contaminated site.

When a property is governed by a qualified environmental remediation plan, it is subject to a governmental restriction on the property's use. Obviously, the contamination and the future costs of remediation or containment significantly reduce the property's real market value.

One way to measure the reduction in market value caused by the government's environmental restrictions is to calculate the present value of the future clean-up costs. The assessing authority will consider the responsibility and costs of remediation or containment, and will usually reduce the real market value of the property significantly.

Another common governmental usage restriction occurs when a governmental agency provides low-interest loans or tax incentives as a means of encouraging development of certain types of public interest projects, such as low-income housing. The government loan will typically require that the property reserve a number of units for lease at a below-market rent.

In Oregon, the statute allows the property owner to choose whether it wants to enter into the special assessment program for low-income housing. A caution to the property owner that enters into the special assessment program for low-income housing is that the property could become subject to back taxes if it later fails to meet the requirements of the county, or of the loan.

Importantly, the statute does not require the property owner to enter the special assessment program to achieve the tax benefit of certain low-income housing units, as long as the loan meets certain statutory requirements and is properly recorded.

Not to be missed is the construction-in-progress exemption, which is available for income-producing properties. Most states encourage the development of commercial and industrial facilities by sheltering construction projects from the payment of taxation until the property is in use or occupied, and therefore generating rental income or enabling an owner-occupier to pursue business activities there.

The construction exemption requires strict compliance with the statute, and inadvertently failing to meet one of the criteria could cost the property owner a year of tax savings. The exemption isn't limited to manufacturing facilities; the Oregon Tax Court has held that this tax exemption is also available to a condominium under construction, provided that the units were held for sale until its completion.

While taxpayers in Portland's hot construction market enjoy many opportunities to take advantage of tax reductions, owners all across the state should be on the alert for these potential reductions.

Cynthia M. Fraser is a partner at the law firm Garvey Schubert Barer where she specializes in property tax and condemnation litigation. Ms. Fraser is the Oregon representative of American Property Tax Counsel, the national affiliation of property tax attorneys. Ms. Fraser can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..
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Nov
14

Property Taxes Should Reflect Retail’s Apocalyptic Times

Instead, assessors continue to ignore the clear fact that brick-and-mortar retail is in massive decline.

The retail sector is experiencing its darkest period ever, and taxing entities must come to grips with declining shopping center values.

News reports confirm that national retailers are closing stores at a record pace. In 2017 alone, retail mainstays such as JC Penney, Sears and Macy's have shuttered hundreds of stores. Leading market analysts including Credit Suisse and Cushman & Wakefield have predicted the closing of some 10,000 brick-and-mortar stores.

Even worse, many national retailers are filing for bankruptcy protection, with several others on analysts' watch lists. The more than 300 retailers reported to have filed for bankruptcy protection in 2017 include several major brands, from Payless ShoeSource to Gymboree and Wet Seal. These dire conditions have spurred some economists to describe the ongoing blood-bath as a retail apocalypse.

Double Trouble

There are two main reasons for the retail sector's decline:

First, consumer preferences are migrating from shopping at brick-and-mortar stores to more online shopping. Online sales increased by about $40 billion in 2016 and accounted for nearly 42 percent of all retail sales growth that year. Amazon alone accounted for 53 percent of that growth, reportedly quintupling its North American sales to $80 billion in 2016 from $16 billion in 2010.

Second, today's consumers would rather spend their money on experiences than on material goods. They prefer dining out, going to movies and travel over buying more shoes, jeans, and electronics. And when they buy goods, they are increasingly likely to buy them online.

These ongoing changes in consumer behavior have resulted in a disturbingly high inventory of vacant retail space, made worse by years of over-building in the sector. The United States reportedly has 40 percent more retail space per person than Canada, five times more than the United Kingdom and 10 times more than Europe.

Shopping malls have been particularly affected. Once popular destinations, many regional malls now scramble to find quality tenants and to attract shoppers. To survive, some malls have taken desperate measures to steer customers to their stores, such as hosting amusement parks and concerts. Sadly, analysts predict 20 to 25 percent of U.S. shopping malls will close within the next five years. The market is simply oversaturated.

Value Questions

Consequently, retail property value has plummeted. What once was seen as a safe investment is now fraught with risk. Suffering national retailers have made retail real estate riskier as the chances of store closures and tenant bankruptcies have increased. Investors only value retail properties highly when those assets are generating a reliable stream of rental payments from high-quality tenants. But with department stores, electronics retailers and apparel shops boarding up, there is insufficient demand to sustain the rental rates and occupancy levels necessary for many properties to support historical values.

Unfortunately, tax assessors are turning a blind eye to this new reality, continuing to assume that there is a viable market with robust buyer demand for this property type.

In many jurisdictions, tax assessors have even raised taxable values on retail properties. This has obviously created confusion among property owners, as the values assessed by taxing jurisdictions conflict with selling prices that owners can garner on the open market.

When vacant properties go up for sale, they may linger on the market for years. And when they do sell, they are often sold to unconventional users, such as hospitals, trampoline parks, call centers, churches and schools. These buyers know that they can leverage the market oversupply to achieve low acquisition prices.

When owners point to sales of comparable — and often vacant — retail properties as evidence of market value, tax assessors accuse them of applying the "Dark Store Theory," which many assessors have mischaracterized as a tax loophole. Assessors have even convinced news media organizations of this misconception, evidenced by headlines such as "Sinister-Sounding Dark Store Theory Is Corporate Welfare and "How Big-Box Retailers Weaponize Old Stores."

This has fueled an ongoing debate concerning how to properly value the fee-simple interest in income-producing property, which in most jurisdictions is the taxable value.

In essence, tax assessors claim that retail property owners are trying to escape taxation by calculating taxable value based on the asking rents and sales of vacant retail locations, rather than on actual rents and sales of occupied properties. Tax assessors contend that property owners are comparing apples to oranges.

Property owners counter that assessors are overstating real estate value by capturing the additional value of non-taxable assets, such as long-term leases with brand-name retailers.

Despite this debate, there is no hiding the fact that retail is going dark. Shopping malls and oversized big box stores have become largely obsolete, bankruptcies and store closures plague the industry, and the glut of retail space grows. Preferences for on-line shopping and consumer purchasing patterns are here to stay.

We are reaching a point where the "dark store is the norm. The market has turned previous assumptions about variables such as market exposure, vacancy, capitalization rates and market rents on their heads, resulting in a retail meltdown.

Daniel R. Smith is a principal with and general counsel for Austin, Texas law firm Popp Hutcheson PLLC, the Texas member of American Property Tax Counsel, the national affiliation of property tax attorneys. James Johnson is a graduate student at Texas A&M University's Real Estate Center and tax analyst for Popp Hutcheson. They may be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.
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Sep
28

Where Has All The Value Gone In Retail?

Telltale signs can signal opportunities for tax reductions in declining retail properties.

For a number of years the mantra in the retail industry has been that retail property values and shopping center values, in particular, will continue to decline because consumers make purchases online rather than in brick-and-mortar stores. While this may be true, simply reciting the words to property tax authorities rarely succeeds in arguing for a reduced assessment.

The best strategy to obtain significant tax reductions for declining retail properties is an analysis of indicators that measure the mall's or shopping center's health. These factors come in four categories: anchor tenants, in-line tenants, tenant occupancy costs and prevailing lease agreements. While these dynamics may not be readily apparent, their analysis is the key to obtaining property tax relief.

Anchor Tenants

Mall anchor tenants have a significant say in how the property is configured, and in the mix of inline tenants. Consequently, when a national chain department store or other anchor tenant starts to experience a decline in sales per square foot, it can send tremors through the entire shopping center. Declining anchor tenant sales grow more serious when the anchor tenant's sales per square foot fall below the national chain-wide average. If the anchor consistently underper­forms the chain-wide average, the store is often deemed a candidate for closure.

Inline Tenants

Inline tenants are the bread and butter of most shopping centers. No other group receives more scrutiny than tenants occupying 10,000 square feet or less. The first thing mall evaluators look for is the types of inline tenants, as well as the trends in those tenant types. Landlords and investors prefer permanent inline tenants over temporary tenants. It is also better to have retail inline tenants than non-retail users, such as offices, government agencies and the like. Of course, the level of inline vacancy is also important because higher vacancy levels may trigger co-tenancy clauses in leases, thereby permitting tenants to vacate before their leases expire.

Tenant Occupancy Costs

The trend in tenants' cost of occu­pancy (COO) may be the best predictor of inline tenants' future performance. By extrapolating COO trends, it is also possible to project a mall's performance several years into the future.

The COO measures the ratio between gross sales and real estate ex­penses, including rent, maintenance charges and other costs that a tenant bears. The COO ratio for Class B and higher malls is usually in the 13 per­cent to 17 percent range, depending on the strength of the tenants, and between 10 percent and 12 percent for lower-end Class C malls.

COO ratios that are higher than these ranges indicate tenants are spending more of their gross revenues to pay property occupancy costs. This reduces the available revenues to pay other operating expenses and, obviously, limits the tenant's profits. Year-over­year increases in COO ratios means tenants are experiencing increasing financial pressure. Eventually, COO ratios become so high tenants will either ask for rent relief or other lease conces­sions, or just walk away.

Prevailing Lease Agreements

Most inline tenants enter into triple­net lease arrangements with the prop­erty owner when a shopping center first opens. Triple-net leases require tenants to pay for maintenance, insur­ance, real estate taxes and other property operating expenses, including the cost for operating common areas within the mall. As a mall declines, inline tenant sales per square foot dwindle, rental rates for new tenants decline and COO ratios increase. At some point, tenants will be unable to pay their rent and still make a profit. At this point, they are likely to ask the mall owner for some type of rent relief.

Rent relief for inline tenants takes different forms, but usually consists of converting triple-net leases to leases paying a percentage of sales, or some­times to gross leases, both of which make the mall owner bear more operating costs. An increase in the number of percentage and gross leases shows that inline tenants are unable to generate enough sales to pay rent and other occupancy expenses.

As more and more leases become percentage or gross leases, the expense burden on the mall owner increases, and the likelihood grows that the mall will close. During this time, the mall owner may replace departing inline tenants with new tenants that demand gross lease arrangements, which further contribute to the mall's decline.

Seek Early Property Tax Relief

The four factors discussed above are interrelated. The progression of falling dominoes starts when the anchor tenant's sales begin to decline. This then leads to a fall in the number of permanent inline retailers, a rise in COO ratios, and the replacement of preferred triple-net leases with percentage or gross leases. All these factors put downward pressure on a retail property's value, which typically reduces the property's tax assessment.

Most of this sequence cannot be observed because it happens below the surface, but it may be the precursor to a mall's failure. Thus, the local property tax authority may not realize a mall is in decline until it falls off the cliff, as when an anchor tenant closes its doors or high-end retailers fail to renew their leases and move to other malls.

Astute retail property owners and operators will identify the underlying problems in a mall or shopping center early on, and bring those difficulties to the attention of the local tax assessor. Doing so may reduce taxes - and mall operating expenses - well before a property is in free-fall mode. If the tax relief is significant and obtained early in the process, it may even extend the life of the mall.

Cris K. O'Neall is a shareholder at the law firm Greenberg Traurig, LLP and focuses his practice on ad valorem property tax assessment counseling and litigation. The firm is the California member of the American Property Tax Counsel, the national affiliation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..
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Sep
25

Louisiana: Tax Exemption For Partially Completed Construction?

Passage of a new ballot initiative will confirm exemption of partially completed property from taxation."

Any taxpayer planning to develop a new property must consider how local taxing entities will treat the project during construction, but the question is especially important in evaluating and comparing overall costs of potential development locations during an industrial site search.

States generally recognize Construction Work in Progress (CWIP) as property that is in the process of changing from one state to another, such as the conversion of machinery, construction materials and other personal property from inventory into an asset or fixture by installation, assembly or construction. There is no clear consensus among taxing jurisdictions as to whether (or how) a tax assessor should value such par­tially completed construction on the applicable assessment date.

Many states including Alabama, Missouri and North Carolina value CWIP based on the value or percentage of completion on the assessment date. Kansas values incomplete construction based on the cost incurred as of the assessment date. Florida, Maryland, Virginia and West Virginia assess CWIP when the work has progressed to a degree that it is useful for its eventual purpose. And in South Carolina, improvements are only assessed upon completion.

With the exception of a few errant assessments in the early 1930s, Louisiana has never assessed partially completed construction for property tax purposes. Rather, taxing jurisdictions assess and add the completed property to tax rolls as of January 1 of the year immediately following completion of construction. This complements Louisiana's industrial tax exemption program, which exempts certain manufacturing property from ad valorem taxation for a specified number of years.

Unfortunately, properties on which ad valorem taxes have been paid are ineligible for participation in the exemption program. Thus, if a taxpayer has paid taxes on a project as partially completed construction, the property is no longer eligible for the industrial tax exemption and remains on the taxable rolls, subject to assessment each year. Obviously, assessing projects with partially finished construction in this manner would significantly diminish the value of the exemption pro­gram to taxpayers and undermine its usefulness to economic develop­ment agencies as an incentive tool.

In 2016, a local assessor broke with established practice and initiated an audit that included construction work in progress on a major industrial taxpayer. This audit raised statewide and local uniformity concerns over the assessment of a single taxpayer's partially completed construction in a single parish, and jeopardized the taxpayer's existing industrial tax exemption.

The taxpayer immediately filed an injunction action in district court, and the Louisiana Legislature took up the situation during its regular 2017 legislative session. Recognizing the need to formalize the exemption, the Legislature referred to voters a constitutional amendment that would codify the exemption of construction work in progress from assessment. Louisiana is one of 16 states that require a two-thirds supermajority in each chamber of the Legislature to refer a constitutional amendment to the ballot, so their vote underscores the strong support among lawmakers to codify the exemption.

Act 428 would add a subsection to Article VII, Section 21 of the Louisiana Constitution, which lists property that is exempt from ad valorem tax assessment. The new provision would exempt from ad valorem tax all property delivered to a construction project site for the purpose of incorporating the property into any tract of land, building or other construction as a component part. This exemption would apply until the construction project is completed (i.e. occupied and used for its in­tended purpose).

The exemption would not apply to (1) any portion of a construction project that is complete, available for its intended use, or operational on the date that property is assessed; (2) for projects constructed in two or more distinct phases, any phase of the construction project that is complete, available for its intended use or operational on the date the property is assessed; (3) certain public service property.

If voters approve the ballot item, CWIP will be exempt from property taxes until construction is "completed." The proposed amendment defines a completed construction as occurring when the property "can be used or occupied for its intended purpose." The exemption would thus remain effective until the construction project or given construc­tion phases of the project are ready to be used or occupied.

A constitutional amendment does not require action by the Governor. This constitutional amendment will be placed on the ballot at the state­wide election to be held on Oct. 14, 2017.

Angela Adolph is a partner in the law firm of Kean Miller LLP, the Louisiana member of American Property Tax Counsel, the national affiliation of property tax attorneys. She can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..
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Sep
11

Misnaming, Misusing The Dark Store Theory

What's in a name? Discussing valuation principles with concise language avoids misunderstanding.

Dark store theory is being used incorrectly to name what is standard, accepted, and proper appraisal practice. It is most often employed by news media to mistakenly suggest that big-box storeowners are taking advantage of a property tax loophole and arguing that a property should be valued as if it were vacant even when the store is open and operating.

While the words "dark store" evoke images of villainous or nefarious activity, assessors and taxpayers should see through this provocative language.

The phrase often confuses the fee simple (absolute ownership of the real estate subject only to governmental powers) market value of the real es­tate with other types of quantifiable value, such as investment or insurable value.

Investment value reflects value to a specific investor based on his own in­vestment requirements, while insur­able value reflects improvements or the portion of the property that may be destroyed.

Typically, property taxes should only be assessed on the real estate value. That's why it's important to differentiate property value for real estate tax assessment from other types of value.

What local law deems real estate value often is different from the property's value to a lender or investor. For example, an owner may include large manufacturing equipment as part of collateral for a mortgage.

This equipment may be valued along with the real estate in determin­ing a loan amount, and may even be included in a financing appraisal; yet the value of that equipment should not be taxed as real estate.

Although this careless and unsys­tematic misapplication of dark store theory concerns commercial real es­tate, we will use examples of single­family homes to illustrate its con­cepts.

Comparable sales valuation

In many jurisdictions, assessors value the land, building and improve­ments for real estate tax purposes. If using sales of comparable proper­ties to determine value, the assessor should examine exactly how much was paid, by whom, for what.

If the sale price of the compara­ble property includes value for an above-market lease, for unusually favorable financing terms, or for an above-average credit rated tenant, the assessor must adjust the sale price to reflect market conditions. The flip side is also true: a sales price based on below-market rent should also be adjusted.

Users of the "dark store theory" label often argue that a busy store deserves a higher real estate tax as­sessment because a large and sophis­ticated company is running a suc­cessful business there. But excluding business value from the real estate as­sessment doesn't mean that the prop­erty owner made ill-advised business decisions.

The adjustments recognize that the sale included additional sources of value or achieved valuable business objectives in addition to the exchange of real estate. The value of these items is separate, and must be excluded from the real estate value for tax pur­poses.

Consider this residential example: a buyer pays 20 percent more than the high end of the market range to buy the house next door to the buyer's brother. The two families have chil­dren of similar ages and expect to save money by carpooling and shar­ing child care and other expenses.

The buyer is acting in his own self­interest and values the proximity to the brother's household, and the ob­jectives the buyer will meet by living next door. That does not mean that the additional money the buyer paid for those considerations increases the value of the house itself to the typical buyer.

lf an appraiser uses this purchase price as a comparable sale to value a similar house across the street, the purchase price should be adjusted to reflect a more typical market partici­pant.

Similarly, any sales of comparable properties used to value big-box retail stores must be adjusted to exclude any value paid for items that are not real estate, whether they are an above­market-quality tenant, atypically long lease duration or other intangible property.

Income approach valuation

Two distinct and important issues get muddied by dark store adherents in valuations based on potential in­come generation.

The first is whether the properties are valued as if vacant, or as if occu­pied at market terms. Valuation as if occupied at market terms by a typi­cal market tenant does not include a landlord's lease-up time and costs, which are factors in the value of a va­cant property.

Secondly, there will generally be a correlation between better retail properties in better locations and the financial strength of the tenants in those properties and areas. Howev­er, the business success or failure of a specific tenant cannot be the basis of a real estate tax assessment if that tenant is not representative of the market.

Returning to the single-family world, houses in desirable areas with good schools, municipal servic­es and low crime rates are generally occupied by people with higher in­comes than homes in less-desirable areas.

However, that does not mean that the income of a specific resident deter­mines the value of the house that he or she occupies. If a brain surgeon and a retail cashier are next-door neighbors in similar houses, the values of the homes do not change.

If two similar retail stores are located in a similar area, but one is gener­ating extremely high store sales while the other is vacant because of a business decision to exit the local market, the value of the properties for real es­tate tax purposes should be the same.

Valuing property is always fact intensive, and the array of specifics dif­fers from situation to situation. There are no shortcuts to an accurate and fair tax assessment value. If the data used is bad and valuation process sloppy, the value conclusion will also be wrong. Consistent and rigorous analysis is vital.

Don't be fooled by labels

Proper appraisal methodology does not become nefarious just because it is erroneously called a "dark store loop­hole." A rose by another name would smell as sweet. Taxpayers need to pay attention when the term "dark store" is bandied about - it is often used to confuse important appraisal concepts and practices.

To be fair and uniform, property taxes must be assessed only against the real estate, and be based on accurate data reflecting typical market participants. Value related to the success of the retailer's business is captured by other taxes levied on income, sales or commercial activity.

To include those items as part of the property tax assessment is not closing a tax loophole; it amounts to double taxation.

Ignore incendiary language and apply appraisal methodology consistently and diligently to arrive at a fair value for real estate taxes.

Cecilia Hyun is an attorney at the law firm Siegel Jennings Co, L.P.A., which has offices in Cleveland and Pittsburgh. The firm is the Ohio and Western Pennsylvania member of American Property Tax Counsel. She can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..
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Sep
01

Don't Let Taxing Authorities Kill Your Deal

Tips from a veteran attorney on handling the assessments that can spell the difference between a successful closing and coming up short.

Almost every week, I get calls from brokers or investors who want to know how property taxes could impact a potential purchase. With property taxes forming the largest variable expense in most real estate acquisitions, investors should question the tax implications of every deal.

In some jurisdictions, the effective property tax can reach 5 percent of market value, so an unexpected increase can cause a deal to go under. With planning and an understanding of the local environment, however, investors can fully appreciate the risks and expenses, and may be able to come in with a winning bid in a tight market.

Most of the inquiries I receive relate to properties in Ohio or Pennsylvania, where school districts can, and do, file appeals to raise taxes on real estate. In those states, the aggressor is often a school board that seeks to value an asset based on its recent sale price. In other states, it may be the county assessor. Some states have deemed it unconstitutional to "chase" sales in setting taxable value.

Know your district

Knowing which states have aggressive taxing authorities can reveal potential problems, but familiarity with those agencies and their personnel is the key to deciding whether to walk away from a deal or to stay and find a creative solution, resulting in a deal that is favorable to everyone.

An examination of any real estate purchase, whether office, retail, hotel, etc., in the context of various taxing districts' behavior illustrates the importance of thoroughly knowing your taxing authority. In all the following examples, assume that the property is uniformly assessed and that the current assessment is consistent with the value of competing properties.

Also assume that the property is assessed for less than the proposed sale price, and that increasing taxable value to the amount of the purchase price would ruin the deal.The first example takes the case of a taxing district with an aggressive, unyielding district attorney. The tax district's counsel is unwilling or unable to see that the tax increase will end up lowering the property's value below the purchase price.

In this scenario, the assessment is raised to the purchase price, which becomes part of the tax budget. Since taxing entities typically establish tax rates based on the overall assessment of the community, the tax district only gets a single year's increase in tax revenue. In subsequent years, the newly increased tax burden weighs down the property's market value, ending in an eventual refund of taxes. The net effect is a loss for the district and a loss for the taxpayer, though the taxpayer eventually recovers some of those losses. It is altogether a lose-lose situation.

Big gambles

The relatively passive school district occasionally files an increase appeal and generally isn't driven to get the last penny from the taxpayer. At first this seems like a good situation. Although a passive district may be less difficult to deal with than a more aggressive counterpart, it still leaves the buyer with a great deal of uncertainty. Risking large sums of money on chance is gambling, not investing.

The advice to the investor in a passive district rests greatly upon the taxpayer's risk tolerance, and upon local counsel's experience with how cases are typically settled. In some instances, the investor could assume that the case would be settled similarly to past cases. This requires counsel that has enough experience with the district to gauge the risk as well as the possible outcome. It also requires that the buyer fully understand the nature of the risk.

Finally, there are districts with counsel that is both reasonable and creative. In that situation, attorneys have been able to resolve tax questions with the district in advance of closing. This allows for the obvious decrease in risk. As in the previous example, it takes a great deal of experience with the opposing attorney.

Of note, approaching a district early can produce a better result. Taxing authorities have become more likely to pursue appeals of assessments, and the chances that a sale will go unnoticed—and that an assessment will go unchanged—are becoming slimmer.

Due diligence means more than determining what might happen; it requires arranging the deal to whatever extent is possible to bring about the desired outcome. Paper the file with an appraisal that satisfies any allocations, and make notations in the purchase agreement that support the tax strategy.

Being able to explain the nature of the purchase later in a tax hearing is important, but having facts and documents that support those assertions is much more valuable. With the right opportunity and preparation, an investor may be able to enter into an acquisition while eliminating risk that has driven away the competition.

J. Kieran Jennings is a Partner at the law firm Siegel Jennings Co, L.P.A., which has offices in Cleveland and Pittsburgh. The firm is the Ohio and Western Pennsylvania member of American Property Tax Counsel. Kieran can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..
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Aug
22

Delaware Court Unlocks Opportunities to Reduce Property Tax Burden

Reducing property tax assessments can be challenging under the best of circumstances, and distinctions between state tax systems make minimizing that burden across an office or industrial portfolio especially daunting. But a recent Delaware Supreme Court decision provides taxpayers with a new, yet surprisingly familiar, opportunity to ease the tax burden on properties in The First State.

Delaware's Tax Assessment System Shows its Age

Under Delaware law, property must be valued at its "true value in money," a term interpreted to mean the property's "present actual market value." However, in order to implement the Delaware Constitution's mandate of tax uniformity, the state applies a base­year method of assessing property. That means that all property in a jurisdiction is assessed in terms of its value as of a certain date, and that value remains on the books indefinitely until the jurisdiction performs a general reassessment. For Delaware's northernmost county, New Castle County, the last reassessment occurred in 1983, so all property therein is valued as of July 1, 1983.

A major challenge to contesting assessments in Delaware is that a taxpayer must determine the property's 1983 market value. Determining what a property is worth today is not always easy, but proving a property's value as of three decades ago has proven increasingly difficult. Furthermore, in the absence of regular adjustments to a property's assessed value, the county asserts that a property should be valued either as it existed in 1983 or, if it was built after 1983, as if it is new and undepreciated.

Delaware's courts have explained that taxpayers have two options in assessment appeals. The first option is to use data from the base year. The property owner could, for example, find sales of comparable properties in or around 1983, or using prevailing market rents and capitalization rates from 1983. The alternative route is to calculate the current market value of the property and "trend back" that amount to 1983. The County Board of Assessment Review has expressed a near-absolute preference for 1983 data, and rarely finds a taxpayer's trending formula acceptable.

The inequities of this practice are blatant. Under the county's interpretation of the base year system, a building constructed in 1983 and located next door to a similar new building should be assessed and taxed at the same level, even though buyers, sellers and tenants are likely to value the buildings quite differently. If the owner of the 34-year-old building wanted to contest its assessment, the owner would have to identify data for new buildings in 1983. Of course, as time marches on and years turn to decades, relevant data from the base year becomes increasingly difficult to find.

Taxpayers Highlight the System's Obsolescence

Taxpayers have raised many challenges to Delaware's assessment system, but most successful challenges have been fact-specific, and no recent court has gone so far as to order Delaware's counties to complete a reassessment. But after several attempts, the taxpayers in Commerce Associates LP v. New Castle County Office of Assessment successfully underscored the largest flaw in the system.

One Commerce Center is an office condominium building in Wilmington, Delaware. The county originally assessed each office condominium upon construction in 1983. After keeping the same tax assessment for decades, the owners of several of the condominiums challenged their assessments in 2015.

Before the County Board of Assessment Review, the owners presented five different analyses. Two analyses relied on comparable sales transactions, one using 1983 sales of buildings that were about 32 years old, and one using modern asking prices trended back to 1983 using the Consumer Price Index (CPI). Two analyses relied on income, one using 1983 data and one using 2015 data trended back to 1983 using the GPI. The fifth analysis employed a cost approach using the original construction expense and reflecting depreciation. These approaches showed that the properties were over-assessed by more than 40 percent.

The county presented evidence of the condominiums' sale prices in 1985, when each unit was relatively new. The county also presented an income approach using 1983 data and a cost approach reflecting no depreciation. The county's approaches all supported the original assessed values, and the board ultimately denied the taxpayers' appeals.

State Supreme Court Approves a Decrease

After having their appeals denied by the Superior Court, the taxpayers brought their challenge to the Delaware Supreme Court. In a tersely worded decision, the Supreme Court reiterated that assessors must consider all relevant factors bearing on the value of a property in its current condition. While the County argued that no depreciation was needed because the properties were brand new in 1983, the court noted that the properties were, in reality, more than 34 years old. Failing to account for their age and any resulting depreciation or appreciation resulted in a flawed value.

Although the county has yet to implement the court's decision, the effects of the decision will likely be widespread. Most properties in New Castle County built after 1983 are assessed without any depreciation. Because each tax year brings with it a new opportunity to challenge an assessment, property owners can bring a new appeal reflecting the property's current depreciation to the Board of Assessment Review every year. Ultimately, this could result in the downfall of the decades-old base-year assessment, as the county finds it necessary to update assessments for a larger number of properties.

A number of questions remain unanswered by the court's ruling. How should assessors value properties in areas that were rural in 1983 but are now highly developed? How can taxpayers quantify and reconcile appreciation and depreciation?

Future cases will need to resolve these questions, but for now, owners of Delaware property should evaluate their portfolios and determine whether opportunities exist to improve profitability by reducing property taxes.

Benjamin Blair is an attorney in the Indianapolis office of the international law firm of Faegre Baker Daniels, LLP, the Indiana and Iowa member of American Property Tax Counsel. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..
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Aug
03

Property Owners Celebrate Fair Taxation Ruling by Pennsylvania Supreme Court

"Nearly every state constitution requires uniformity in taxation, meaning that two like properties should receive the same assessment, no matter how they are owned, occupied, built or financed."

Commercial property owners around the country are cheering a recent Pennsylvania Supreme Court decision that breathes new life into constitutional guarantees of uniformity in taxation.  Overruling a decade of lower court decisions, the ruling reestablishes the primacy of constitutional uniformity protections to taxpayers in the strongest possible language, fittingly issued just one day after the July 4 holiday.

Nearly every state constitution requires uniformity in taxation, meaning that two like properties should receive the same assessment, no matter how they are owned, occupied, built or financed.  Yet commercial property owners across the nation have been under attack by assessors attempting to alter appraisal theory in order to pin higher assessments and higher real estate taxes on specific owners.

These assessors have been singling out occupied commercial properties by setting assessments based on financing mechanisms that fail to meet standard appraisal definitions of market sales, incorrectly basing taxable value on data relating to sale-leasebacks, turnkey leases and contract rights arid duties associated with tenant financing.

In Pennsylvania and Ohio, the only states that provide school districts a statutory right to file increase appeals, the school districts have been targeting specific commercial owners for higher assessments using this same flawed methodology.  These selective or “spot” appeals disrupt constitutionally required uniformity in assessment.  Many Pennsylvania school districts have been paying contingency fees to behind-the-scenes consultants to select properties for appeal.

Commercial Portfolio Owners Beware

The consultants’ favorite repeat targets are national real estate portfolio owners that cannot vote in local school board elections.  The practice has gained traction over the past five years, with national companies being forced to defend against an ever-increasing number of increase appeals in which school districts seek discovery of the property owner’s confidential real estate information and then use it against the owner to justify an increase in assessment.

This practice violates fundamental fairness and puts targeted commercial owners at a competitive disadvantage with commercial owners whose assessments are not increased.  It also shifts more of the tax burden from residential to commercial owners, since most school districts are loathe to sue voting residential owners to increase their assessments.

In Valley Forge Towers Apartments LP vs. Upper Merion Area School District, the school district filed increase appeals only against commercial property owners and not against residential owners.  The district selected properties for appeal after consultation with Keystone Realty Advisors, a New Jersey tax consultant that employs trained appraisers and takes a 25 percent contingent fee on any increase in taxes resulting from its recommended appeals.

Four apartment building owners that had been targeted for these appeals challenged the school district’s selection of only commercial owners for appeals as violating the Pennsylvania Constitution’s uniformity in taxation requirement.  Both the trial court and the first-level appellate court denied the taxpayers’ challenge, holding that the school districts goal of increasing revenue justified the selective nature of the appeals.

The Pennsylvania Supreme Court reversed those rulings.  The court stated that all taxpayers must be uniformly treated, whether they are residential or commercial owners, and that no assessment scheme can systematically treat residential and commercial taxpayers differently.

The court stated no less than 13 times that all real estate is a single class.  The court observed that this constitutional tenet has been in place since 1909 and was reaffirmed by the court on multiple occasions, and that the court had no intention of discarding it.  The court then stated that the government may not create sub-classifications of property for different tax treatment, a point it repeated nine more times in its decision.

What the Ruling Means Going Forward

The ruling makes it abundantly clear that all real estate must be taxed uniformly, and that this constitutional protection is for the benefit of the taxpayer:

“First, all property in a taxing district is a single class, and as a consequence, the uniformity clause does not permit the government, including taxing authorities, to treat different property sub-classifications in a disparate manner,” the court stated.  “Second, this prohibition applies to any intentional or systematic enforcement of the tax laws and is not limited solely to wrongful conduct.”

The court then remanded the case to determine if there was a systematic disparate treatment of the Valley Forge taxpayers.  It will be unnecessary to show that the school intended to treat the taxpayers differently from other taxpayers.

The principal takeaway from the case is that all taxes must be uniformly assessed, and that any purposeful or unintentional systematic assessment that treats taxpayers in a disparate manner is unconstitutional.

The Pennsylvania Supreme Court’s decision underscores the need for a real estate taxation standard that treats residential and commercial properties uniformly.  In current practice, assessors around the country assess commercial and residential properties using different standards.  Residential property is taxed on a fee-simple, unencumbered basis: that is, the property is assumed to be vacant and available for purchase as of the assessment date.

Commercial property, on the other hand, increasingly has been assessed on the assumption that it is occupied by a successful business.  In those instances, the assessment reflects the way that the business finances its occupancy, whether it chooses to lease the building or own it outright.  Commercial property frequently trades as part of an ongoing business or with long-term leases, deed restrictions or other use restrictions in place.  But to be uniform, property taxes must rely upon a single interest valued for tax purposes.

The only interest that is uniform across all categories is the fee-simple, unencumbered value.  As the Valley Forge decision makes clear, there can only be one standard because all real estate is a single class.

Now, across the country, tax professionals can use the Valley Forge decision to bring fairness to commercial property owners.

Sharon DiPaolo

Sharon DiPaolo is a Partner in the law firm Siegel Jennings Co, L.P.A., which has offices in Cleveland and Pittsburgh.  The firm is the Ohio and Western Pennsylvania member of American Property Tax Counsel. Sharon can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Jul
10

Tax Rules Clarified For Section 42 Housing

"Wisconsin Supreme Court reaffirms subsidized housing valuation methods."

In a major victory for subsidized housing developers and investors, the Wisconsin Supreme Court has reaffirmed longstanding principles governing the assessment of these properties.

The Dec. 22, 2016 decision in Regency West Apartments LLC v. City of Racine confirms that the assessment of a subsidized housing project is a property-specific exercise that must take into account the type of federal program involved, specific restrictions on the property and actual property income and expenses.

The decision also affirms that the value of a subsidized property cannot be determined by comparison to conventional apartment properties that have no restrictions and can charge full market rents.

Historical context

The Wisconsin Supreme Court first upheld these principles in a 1993 case involving a Milwaukee apartment project subject to rental and other restrictions imposed by the U. S. Department of Housing and Urban Development (HUD).

The assessor had valued the property based on market rents at conventional apartments, ignoring the property owner’s inability to legally charge market rents. The Supreme Court nullified the assessment, stating that the assessor had illegally assessed the property by “pretend[ing]” that the HUD restrictions did not apply.

The new decision

In the December 2016 decision, the Supreme Court reaffirmed the 1993 decision and announced additional rules governing what assessors cannot do in assessing subsidized housing.

That case involved 72 rental units regulated under Section 42 of the Internal Revenue Code, which provides federal income tax credits for investors in affordable housing. Regulations governing the property restricted both rent and tenant income levels, and required the owner to enter into a 30-year land use restriction agreement.

For the first of the two tax years in issue, the assessor valued the project under an income approach but failed to consider the owner’s actual income and expense projections. Instead, the assessor estimated vacancy and expenses using a mass-appraisal model comprised of market vacancy rates and market expenses for unrestricted properties.

The assessor also used a low 6 percent base capitalization rate, likewise derived from a mass appraisal model consisting of market-rate properties.

For the second year in issue, the assessor used a comparable sales approach based on sales of three properties that the assessor claimed were comparable to the subject property. However, none of those properties was a Section 42 project: Two were rent-subsidized HUD Section 8 properties, and the other was a mixed-use property consisting primarily of market-rate apartments with a few Section 42 units.

The Supreme Court nullified the assessments for both years, concluding that neither approach the assessor used complied with the rule that an assessor cannot value subsidized housing by “pretend[ing]” that the restrictions on the property do not exist.

For the income-based assessment, the Supreme Court found two fatal flaws in the assessor’s methodology.

First, the court found that the assessor violated Wisconsin law by using estimated market-based vacancy and expenses instead of the property’s projected actual vacancy and expenses. The court reaffirmed that its 1993 decision “unambiguously” requires assessors to use actual income and expenses when valuing subsidized housing under an income approach.

The court further held that by using mass appraisal estimation techniques instead of income and expense information specific to the subject property, the assessor violated the statutory requirement that assessors must use the “best available” information.

Second, the court found that the assessor violated Wisconsin law by deriving a capitalization rate from market-rate properties instead of from the specific market for Section 42 properties. The court explicitly held that Wisconsin assessors valuing federally regulated properties “may not” derive a capitalization rate from market-rate properties.

For the comparable sales-based assessment, the court likewise concluded that the three sales the assessor relied on were not “reasonably comparable” to the subject property, as Wisconsin law requires. The court definitively rejected the assessor’s claim that Section 42 properties and Section 8 properties have similar restrictions and similar rates of rent and are there-fore comparable.

In rejecting the assessor’s claim that those two programs have similar restrictions, the court engaged in a lengthy analysis of the fundamental differences between them.

The court emphasized that the two “are vastly different” programs with “different risks for the owners,” since Section 42 is an income tax credit pro-gram while Section 8 is a rent subsidy program; thus, Section 42 properties are “riskier investment[s]” because the government does not insure against nonpayment of rents.

The court likewise rejected the assessor’s claim that the two programs have similar rents, holding that the comparison was invalid because the assessor failed to recognize that Section 8 rents are subsidized by the government while Section 42 rents are not. The Court thus concluded that as a matter of law, Section 8 and Section 42 properties are not reasonably comparable because they do not have the same restrictions.

Key takeaways

The decision is a major victory for subsidized housing developers and investors for several reasons. First, it reaffirmed the 1993 decision that subsidized housing cannot be valued under an income approach based on the income and expenses of conventional apartments. It also provided additional guidance as to what assessors cannot do, including developing a capitalization rate from sales of non-subsidized properties.

Second, the decision addressed for the first time what assessors cannot do in assessing subsidized housing under a comparable sales approach, since the 1993 case only addressed assessment under an income approach.

Finally, and perhaps most significant for investors in these properties, the decision specifically held that different types of subsidized housing programs – Section 42 and HUD Section 8 in particular – are vastly different, and that assessors cannot consider a property under one program to be reasonably comparable to a property in a different program just because they both involve a form of subsidized housing.

Gordon Robert 150Robert Gordon is a partner in the Milwaukee office of Michael Best & Friedrich LLP.  He is also the designated Wisconsin member of Amercican Property Tax Counsel.  Robert can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.

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Jul
07

Lifting the Veil on Chicago and Cook County Real Estate Taxes

It seems like politics watchers and the news media like to establish a veil of mystery around Cook County tax assessments. And although it sells papers and conjures an atmosphere of the unknown, the most important thing to know about tax relief in Cook County is the role of market value in assessments and how taxes are  calculated.

On June 13, taxing entities announced that tax rates in the City of Chicago would be going up approximately 10 percent. The second installment 2016 tax bills were scheduled to be published around July 1 with a very short payment deadline of Aug. 1, 2017. Those bills will reflect all changes to assessments, as well as the new tax  rates.

Tax increases make good headlines, but the increases were not a real surprise. The large anticipated property tax increases arise from a local ordinance designed to recapture a portion of the City of Chicago's and Chicago Public Schools' large budget deficits and pension plan deficits. This local real estate tax increase resulted from the absence any current resolution of the continuing budgetary stalemate between the general assembly and the governor's office in Springfield, Illinois.

The table below illustrates the potential real estate tax increase that could result from the projected 9.3 percent 2016 tax increase from the previous year's tax bills. It addresses a commercial property in Chicago which had a $10 million assessor's fair market value in 2015, considering the projected 2016 property tax increase of about 10  percent.

Projected Tax Bill
$10 million commercial property

 

2015

2016

Market value

10 million

10 million

x 25 percent assessment ratio

  

Assessed value

2.5 million

2.5 million

Equalization factor

2.6685

2.8032

Equalized assessment

$6,671,250

$7,008,000

Tax rate

6.867 percent

7.145 percent

Tax bill (increase 9.3 percent)

$458,114.74

$500,721.60

News outlets made a splash over the approximate 10 percent increase in the tax rate. However, to satisfy the needs associated with funding police, fire and schools, it is likely that there will be future tax increases over and above that initial 10 percent.

What to do? First, understand that a tax challenge is not surrounded by intrigue. Individuals can very easily appeal their assessments to the assessor. Taxpayers that present good facts and arguments following sound appraisal theory will often find some tax relief. Property owners can take a further appeal to the board of review and beyond. However, at the board level, corporate taxpayers require an attorney.

There are a number of practical arguments to consider. One is to pursue an argument based solely on the assessment as compared to the actual market value of the property, considering the contract rents in  place.

Another is taking what appears to be the opposite approach. When arguing about uniformity, taxpayers look toward the general market. In short, assessments should reflect current market rents and not necessarily the actual contract rent at the subject property.

Taxpayers should also consider market occupancy with an eye toward the limitations of the subject property. These arguments  work best when submitted to the board along with reliable appraisal evidence as supporting material.

From a practical standpoint, a uniformity argument hits close to the response that most taxpayers want, which is to be taxed in a similar manner as their neighbors or competitors in similarly situated  properties.

Most assessments are sub-arguments to the income, sales and cost approaches to determining value. The assessors and boards heavily favor the income approach for commercial properties.

Thus by understanding the limitations of the subject property, the taxpayer can argue his own case or be better able to assist tax professionals in establishing the most accurate assessment for the property. There are no smoke and mirrors required, just sound judgment.

 

jbrown kieran jennings

J. Kieran Jennings is a Partner at the law firm Siegel Jennings Co, L.P.A., which has offices in Cleveland and Pittsburgh.  The firm is the Ohio and Western Pennsylvania member of American Property Tax Counsel. Kieran can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..   Jeffrey Brown is an attorney at the law firm of Fisk Kart Katz and Regan LTD.  The firm is the Illinois member of American Property Tax Counsel.  Jeffrey can be reached at jbrown@proptax.

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Jul
01

Are You Leaving Property Tax Savings On The Table

" In Texas, don't fail to appeal your assessment because the state gives taxpayers unusual advantages as a tax protest. "

Texas enjoys one of the most fair property tax protest systems in the country.

Suing to appeal an unsatisfactory appraisal review board decision is straightforward in Texas. The state property tax system provides taxpayers with a pragmatic approach to air their valuation disputes before the courts, without the delay and headache frequently experienced in other types of litigation. Yet many taxpayers choose not to appeal, relinquishing the opportunity to achieve significant tax savings. Do not be so shortsighted.

Texans enjoy one of the most fair property tax protest systems in the country, beginning with the right to  contest their appraised values through an administrative process. If they do not like the result, they can file a law-suit that provides a fresh start, turning the valuation issue over to a judge or jury, whichever the parties prefer. And if the taxpayer is unsatisfied with the court's decision, he or she can seek review from a state appellate court and even the State Supreme Court.

Not all states provide such a favorable review process. Texas is special.

Built into the Texas Tax Code are processes and requirements that make litigating property tax appeals more efficient and less procedurally burdensome for taxpayers, even if an appeal advances to the state's highest court. Here are a few of Texas' answers to common taxpayer worries.

Are you concerned that your property tax appeal will be a years-long slog?

Property owners who have been involved in lawsuits before may fear that a property tax appeal means protracted litigation, mired in delay and gamesmanship. Fortunately, the Texas Tax Code limits such behavior by providing numerous tools that can help bring the litigation to a quick resolution, like the ones mentioned below. These features do not apply in the initial filing to appeal an assessment, and are peculiar to property tax lawsuits.

Was your lawsuit filed in the wrong property owner's name?

In most types of litigation, a defect in parties could be fatal to a claim, especially if there is a tight window of time in which to file the lawsuit. In Texas, however, a property tax appeal continues despite having the wrong plaintiff so Tong as the property itself was the subject of an administrative order, the lawsuit was filed on time and the lawsuit sufficiently describes the property at issue. There is no jurisdictional problem.

Did you miss the deadline to protest the appraised value?

There are deadline-driven, jurisdictional prerequisites to pursuing a property tax protest, but Texas law provides some limited "back stop" protection in the event these deadlines are missed. For instance, at any time before Feb. 1, when the taxes become delinquent, a property owner may file a motion with the appraisal district to change an incorrectly appraised value that exceeds the correct appraised value by one-third. This is consistent with other statutes designed to be fair, so that property owners can efficiently challenge excessive appraised values.

Would you like to have something akin to a trial, but not necessarily be bound by the result?

The Texas Tax Code allows a property owner to take the dispute to non-binding arbitration. This is particularly helpful when the parties would like to get a sense of what might happen if the matter goes to trial. An independent, third-party arbiter decides who is right and issues a ruling on the valuation question. This procedure can drive more serious settlement discussions. Although the result is non-binding, it may nonetheless be admitted into evidence at trial for the judge and jury to see.

Would you like the appraisal district to meet with you early in the case to discuss settlement?

Upon written request by either side, the parties or their attorneys must meet and make a good-faith effort to resolve the matter. The meeting must take place within 120 days after the written request is delivered. If the appraisal district cannot meet this deadline, the deadline for property owners and the appraisal district to meet will be moved closer to the trial date — 60 days before trial for parties seeking affirmative relief to their complaint, 30 days before trial for all other experts. This allows more time for the parties to discuss settlement with a temporary reprieve from the pressure of having to engage experts and pay for costly appraisals.

Would you like to ensure that both sides produce their expert reports at the same time?

Property owners can do this by, within 120 days of filing suit, making a written settlement offer and identifying which cause of action is the basis for its appeal, meaning a claim for either excessive appraisal or unequal appraisal. At this time, the taxpayer must request alternative dispute resolution, such as mediation.

By triggering this process, property owners may protect their expert's valuation work from being used against them by the appraisal district's expert appraiser when preparing an opposing report. If property owners had to produce their expert appraisal reports first, the appraisal district's expert would likely try to discredit them in its opposing analysis. This "simultaneous exchange" requirement removes the unfair advantage that the appraisal district would otherwise have.

Property owners should not hesitate to continue their property tax protests beyond the appraisal review board level. In Texas, litigation adds numerous tools to the taxpayer's toolbox that can help property owners achieve fair property tax assessments.

 

daniel smith active at popp hutcheson

Daniel R. Smith is a principal with and general counsel in the Austin law firm of Popp Hutcheson PLLC, which focuses its practice on property tax disputes and is the Texas member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. He represents commercial property owners in property tax appeals across the state, and can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Jun
20

Taxation of New York City Real Property

Introduction

This article provides an overview of real estate taxation in New York City (the “City”) including (i) the process by which the City assesses real property, (ii) how property owners challenge the City’s assessments, (iii) benefit programs available to reduce property owners’ real estate tax burdens, and (iv) the importance of understanding real estate taxes in lease negotiations. In New York City, real estate taxes have become an increasingly greater expense for property owners and landlords in recent years. As such, they are an ever-growing factor that any potential purchaser or tenant must account for in its business decisions. Counsel on either side of any real estate transaction should possess at least a basic knowledge of the real estate taxation process to be able to appropriately account for such taxes in negotiations. The process is complex, involves interaction with many government agencies, and is often counter-intuitive. Therefore, a working knowledge of the process is also important in order to understand that, for more complex transactions, specialized real estate tax representation might be necessary and appropriate.

New York City’s Department of Finance (DOF) is the agency charged with assessing all real property in New York City. DOF reassesses all real estate (over one million parcels) each year. Income generated from real estate taxes is the top source of revenue for the City, currently comprising over 40% of the City’s revenue. As a result, real estate taxes are a major factor to account for in the sale / purchase, and leasing of real estate. Furthermore, the City offers numerous real estate tax benefit programs that builders, developers, purchasers, landlords, and tenants need to be aware of in considering any transaction.

Procedures for assessing real property, challenging real estate tax assessments, and qualifying for the various tax benefit programs are governed by the New York State Real Property Tax Law (RPTL) and the New York City Charter, Administrative Code, and Rules.

Arriving at a Tax Assessment

Unlike most jurisdictions around the country, New York City reassesses every property on an annual basis and adheres to a strict and consistent calendar for publication of its assessment roll. Below is a summary of the key dates in the assessment process.

  • Taxable Status Date. DOF assesses real property as of its status and condition each January 5, also known as the taxable status date. This date is particularly important when assessing properties that are experiencing large vacancies as of January 5 or are in various stages of construction and/or demolition. Since the status and condition of these types of properties are likely to change dramatically over the course of the year, their assessments the following year may experience similarly dramatic changes.
  • Tentative vs. Final Assessment Dates. Each parcel of real property subject to assessment is identified on the New York City Tax Maps by a specific block and lot number. An individual tax lot may range from multiple buildings to just one residential or commercial unit in a condominium. On January 15, the City publishes tentative assessments for each tax lot. Between January 15 and May 24 the City has the authority to increase or decrease any assessment for any reason. This is called the change by notice period. During this time period taxpayers can also request a review of assessments if they feel such assessments were made due to usage of erroneous factors (i.e., incorrect square footage). Any changes to the tentative assessment made during this time must be sent to the taxpayer, in writing. The assessment roll closes on May 25 of each year, at which time the final assessment roll is published. This final assessment is the one upon which a taxpayer’s property tax bill is based and the one from which any challenge to the assessment will arise.

It is important for counsel to note that the tentative assessment published on January 15 is not the final word on a property’s tax burden. This assessment should be reviewed for potential errors that should be brought to the City’s attention in advance of the final roll’s publication on May 25. While the City sometimes adjusts errors on its own, there is an opportunity to alert them to potential issues. It is also important to note that this change by notice period exists separately and apart from the administrative and legal challenges to an assessment that take place later and have different deadlines associated with them. That process is discussed in greater detail below.

The Property Tax Bill

When the tentative assessment roll is released each January, DOF provides taxpayers with a notice of value. The notice of value includes many numbers and terms which may cause confusion, but which are important to understand for purposes of what a taxpayer’s real estate tax obligation will ultimately be based upon. Below is a summary of the key terms to understand in the notice of value.

Equalization Rate: In assessing properties, DOF first derives a parcel’s market value which is the City’s determination as to what the property is worth. The City, other than the few exceptions discussed below, assesses properties at 45% of their market value. This is the City’s equalization rate.

Actual Assessment: The City applies the 45% equalization rate to a property’s market value to arrive at its actual assessment.

Transitional Assessment: To shield taxpayers from sudden and drastic annual fluctuations in assessed value, the City provides for a five-year “phase-in” of every property’s actual assessment. Other than an important exception discussed below, this number is generally an arithmetic average of the five most recent years’ actual assessments and is known as the transitional assessment for a property. A property’s real estate tax liability is based on the lower of the actual vs. transitional assessment. As a result, if a property’s actual assessed value increased by $1 million over the previous year’s assessment, the transitional assessment would really only be incorporating 20% of that increase into this year’s transitional assessment. The taxpayer will not bear the full brunt of that large increase immediately.

As an example, take a hypothetical apartment building in Manhattan with the following values and assessments:

Tax Year

Market Value

Actual Assessment

Transitional Assessment

17/18

$8,100,000

$3,645,000

$2,587,500

16/17

$6,400,000

$2,880,000

$2,173,500

15/16

$5,500,000

$2,475,000

 

14/15

$4,750,000

$2,137,500

 

13/14

$4,000,000

$1,800,000

 

12/13

$3,500,000

$1,575,000

 

As you can see, the actual assessment increased by almost $1 million from $2.88 million in tax year 16/17 to $3.645 million in tax year 17/18. However, because the transitional assessment incorporates the five most recent actual assessments, the transitional assessment only increased by about $400,000. The real estate taxes for the property will therefore be based on this lower ($2,587,500) amount. Note that tax years 12/13 – 15/16 would also have transitional assessments based on actual assessment of years not listed. For purposes of illustration only, the focus of this chart is on the two most recent tax years (15/16 and 16/17).

An important exception to note regarding transitional assessment phase-ins comes up when there is construction or demolition being done on a property. In those instances the City adds or subtracts what is called a “physical increase” or “physical decrease” to the property based on the value added or subtracted for the construction or demolition taking place. This physical increase or decrease is not subject to a five-year transitional phase-in and is taxable in the year in which it took place.

Tax Rate: After determining the appropriate billable assessment, a tax rate is applied to the billable assessed value to come up with the real estate tax liability for a particular property. The tax rates vary depending on the class of property being assessed (see below). The rates are set annually by the New York City Council and are not subject to challenge.

Assessment of Different Classes of Property

Real property in New York City is divided into four classes, each with distinct assessment rules as detailed below:

  • Class 1. Properties in tax class 1 consist of primarily residential properties with three or fewer residential units. Essentially these are one, two, and three family homes. Properties in class 1 enjoy highly favorable treatment from a real estate tax perspective. As discussed above, while the City assesses the vast majority of properties at 45% of their city-determined market values, properties in class 1 are assessed at only 6% of their market values. This generally makes their assessed value (and as a result, their real estate tax bill) much lower as compared to the other classes of property. Furthermore, state law places caps on the amount the assessed value for class 1 properties is permitted to increase each year. Specifically, properties in tax class 1 cannot see their assessment increase by more than 6% year over year and by more than 20% over any five year period. As with all other properties, any physical changes to the property are not subject to these statutory limitations on increases and can result in increases that are larger than 6%.
  • Class 2. Properties in class 2 are primarily residential properties with more than three units. Class 2 includes residential apartment buildings as well as cooperatives and condominiums. Within class 2 is a subset of properties (class 2a, 2b, and 2c) that enjoy limitations on assessment increases similar to those that properties in tax class 1 enjoy. Specifically, primarily residential properties in class 2 with fewer than 11 units cannot see their assessments increase by more than 8% per year and by more than 30% over any five year period. These properties include rental properties as well as cooperatives and condominiums. Class 2a properties contain 4-6 residential units; class 2b properties contain 7-10 residential units; class 2c properties are cooperative or condominium properties with 3-10 units. While they are still assessed at 45% of market value (as opposed to the 6% equalization rate for class 1), the statutory caps still provide a benefit to these smaller residential properties. Transitional assessments do not apply to this subclass.

Many of these smaller residential properties that may qualify for favorable tax treatment by being within class 2a, 2b, or 2c also contain a commercial component. Since commercial properties fall within tax class 4 (see below) and do not enjoy any statutory limitations on increase, it is important for an owner hoping to qualify for these statutory caps to make sure the property is considered primarily residential. There is no explicit definition of primarily residential and, over the years, the City has had various policies in determining whether something should be considered primarily residential or commercial. Previously, the City looked at which component generated greater rental income for the building and considered that to be its “primary” function. More recently, greater weight seems to be given to overall commercial vs. residential square footage as well as to the total number of commercial versus residential units within the building in determining whether it would be considered primarily residential for purposes of receiving class 2a, 2b or 2c status.

On April 25, 2017 a coalition seeking tax reform called Tax Equity Now filed suit against New York City and New York State in New York State Supreme Court seeking a declaratory judgment that the entire New York City real property tax system is unconstitutional on various grounds. Specifically, the lawsuit targets the inequity and alleged constitutional infirmities created by the beneficial treatment of class 1 properties and smaller class 2 properties (described above) at the expense of other real estate tax payers among the other tax classes. Furthermore, the suit goes on to claim that this unequal treatment among the tax classes has a disparate impact on minorities. Tax Equity Now claims that since minorities in the City are predominantly tenants in larger class 2 rental apartment buildings which are not subject to any favorable tax treatment, minorities pay a disproportionate share of the City’s tax burden. As a result, wealthier, predominantly non-minority homeowners pay a disproportionately lower real estate tax burden. While this lawsuit will likely take years to be resolved and is not of immediate concern to the accuracy of the information in this practice note, it something to be mindful of as it works its way through the courts.

  • Class 3. Properties in tax class 3 consist primarily of utility properties (i.e., power plants). These are also assessed at 45% of market value.
  • Class 4. Class 4 is all properties that do not fall within tax class 1, 2, or 3. These are essentially all commercial properties, including office buildings, retail spaces, hotels, parking garages, etc. Under New York State law, certain utility related equipment is also considered real property for the purposes of assessment and falls into tax class 4. This property is known as Real Estate Utility Company (REUC) property and is separately assessed by the City of New York. The most common type of property that is assessed as REUC property is emergency backup generators. The assessment of these generators has become increasingly important in the wake of Super Storm Sandy as the sheer number of generators in the City has increased exponentially. From an assessment policy perspective, the City actually differentiates between tenant-owned and building-owned generators. Specifically, generators that are owned by the building are not separately assessed, as they are considered part of the building and, therefore, their presence is deemed to have already been incorporated into the building’s assessment. Conversely, tenant-owned generators are separately assessed and given their own unique REUC Identification Number, which is basically the equivalent of an individual tax lot for assessment purposes. These generators are considered more portable, are more likely to travel with the tenant, and are, therefore, not reflected in the overall assessment of a building.

Particularly with respect to REUC properties, counsel should understand and be aware of the intentions of both sides with respect to backup generator equipment. Do tenants plan to install their own backup generating systems? Will they use some other backup system already in place in the building? These backup generators are not traditionally the type of item one would consider “real estate,” however, New York State Law defines them as such. Furthermore, City policies treat these generators differently based on their ownership status. As a result, they may be subject to additional real estate taxes not initially contemplated in any deal.

Three Methods of Real Property Valuation

Set forth below are the three methods of valuation typically used in assessing real property.

  1. Income Capitalization Approach. The City assesses the vast majority of properties using the income capitalization approach. By law, most owners of income-producing properties are required to provide annual real property income and expense statements to the City (referred to as RPIE). In the simplest cases, the City reviews and adjusts these numbers to arrive at a net operating income for the property. It then applies a capitalization rate to the property to arrive at a market value for the property. As discussed above, the City then generally takes 45% of that market value to arrive at an assessment. However, strictly and blindly applying RPIE numbers to arrive at an assessment becomes difficult when issues of vacancies, construction, and other factors result in the RPIE numbers not necessarily being a reflection of a property’s true value. In these cases, DOF will generally make various adjustments to a property’s net operating income based on annual guidelines and parameters DOF establishes for the various types of properties it is responsible for assessing.

Obviously residential co-ops and condos do not report rental income. Therefore, in order to arrive at a net operating income (and ultimate assessment) for these properties, New York State law requires that co-ops and condos are to be valued and assessed as if they were rental properties. This results in City assessors looking to the rental income market of what they deem to be comparable buildings and applying those rents to the co-ops and condos to arrive at their assessments. A successful challenge to the assessment of a residential co-op or condo would require finding other comparable rentals that more closely reflect and mirror the situations at the subject property being assessed. Since commercial condominium units typically do pay rent, the City assesses them as they would any other individual block and lot. The one caveat is that, since an individual commercial condominium unit is usually part of a larger building containing many condominium units, DOF will generally assess a specific unit based on its percent interest in the common elements of the building as a whole. This percentage figure is listed in the condominium’s declaration. As a result of this methodology, the percent interest of a particular condominium unit is an important factor in the unit’s ultimate tax bill and the ultimate allocation should be considered carefully when drafting and reviewing the condominium offering plan.

  1. Cost Approach. City assessors primarily use the cost approach in valuing specialty properties or equipment (power plants, generators, etc.). They arrive at the assessment by determining what the current cost would be to build a new identical specialty property and then deduct from such cost for depreciation.
  2. Sales Approach. The City has a policy to not reassess properties based on sales prices. Property sales may be used as evidence of value when challenging a property’s assessment; however, they are not the basis of an assessment. The City does review sales when valuing class 1 properties (1, 2, and 3-family homes) and to arrive at market values for those properties. However, as discussed above, since the permissible annual assessment increases for class 1 properties are capped, the market value the City applies based on comparable sales generally has no bearing on the assessment.

How to Challenge an Assessment

As discussed above, DOF publishes tentative assessments for all properties on January 15 of each year. A property owner (or other party with standing) who wishes to challenge that assessment must do so by filing an application with the New York City Tax Commission (the Tax Commission) by March 1 (note that for class 1 the deadline is March 15). Most properties also require the filing of an income and expense statement, which must be filed by March 24. Failure to timely meet these deadlines is a jurisdictional defect which precludes an owner from challenging that year’s assessment.

In order to challenge an assessment, a party must have standing to do so. Generally, any party claiming to be aggrieved by an assessment has the right to challenge that assessment. This has been defined as anyone whose pecuniary interest may be affected by an assessment. As a result, not just property owners, but tenants, partial tenants, and other parties responsible for the payment of real estate taxes may have standing to challenge the assessment upon which those taxes are based.

The Tax Commission is the administrative agency charged with reviewing the assessments issued by DOF. It schedules hearings to review the assessments of all properties that file timely challenges each year. These hearings are held from late spring to early fall each year. At the hearings, the Tax Commission generally reviews the two most recent years’ assessments. However, legally, the agency has jurisdiction to review any two of the five most recent assessments. The Tax Commission may decide to offer a reduction in an assessment or confirm DOF’s assessment. The Tax Commission is prohibited from raising a property tax assessment as a result of a hearing.

DOF publishes its final assessment roll on May 25 of each year.

By June 1 of each year property owners are required to file income and expense statements with DOF, reporting their numbers from the prior calendar year. This is the RPIE filing (discussed above), which must be completed online through DOF’s website.

If an owner is unable to resolve its assessment challenge with the Tax Commission in a particular year, the owner must file a petition in New York State Supreme Court by October 24 of each year in order to preserve its right to litigate over the assessment.

Grounds for Court Challenges/Trials

If an assessment challenge proceeds to trial there are four grounds under which that assessment may be challenged. The assessment must be alleged to be: (i) excessive, (ii) illegal, (iii) unequal, or (iv) misclassified. The vast majority of trials involve a claim of overvaluation.

Trials over an assessment are generally bench trials. The City agency responsible for handling assessment-related litigation is the New York City Law Department. At trial, generally, each side submits an expert appraisal report with conclusions of value and the expert real estate appraiser who prepared the report testifies at the trial. Testimony is usually limited to the four corners of the report.

City assessments are deemed presumptively valid so the burden is on the petitioner to show the assessment was incorrect. Much as in the case of administrative review of the assessment at the Tax Commission, a court is prohibited from raising an assessment as the result of a trial. The City’s assessment can only be confirmed or reduced at trial.

Recently, DOF has provided an additional administrative avenue to challenge an assessment on the grounds that it was based on a clerical error or error of description. New York State law has had a longstanding procedure by which to challenge assessments based on clerical error, however, those sections of the RPTL were inapplicable to New York City. As a result, the City recently amended its rules to codify and apply similar procedures. The types of errors DOF considers under these rules include, but are not limited to, errors in assessments due to: computation errors, incorrect square footage, incorrect number of units, incorrect building class, as well as all other clerical errors specified in Article 5 of the RPTL. DOF will specifically not consider clerical error challenges if the challenges have to do with valuation methodology, incorrect comparables and other valuation-related challenges that are more appropriately challenged in the standard ways described above. Much like New York State law, the new City rules allow DOF to look back up to six years prior to the time a clerical error challenge was filed when considering changing an assessment on these grounds.

Benefit, Abatement, and Exemption Programs

The City offers a wide variety of real estate tax exemption/abatement programs to encourage development of new buildings and renovation of existing buildings, among other things. Below is a summary of the most commonly utilized programs.

  • Industrial Commercial Abatement Program (ICAP). ICAP provides tax abatements for renovating commercial buildings and, in some parts of the City, for building brand new industrial/commercial buildings. In some instances even renovated or newly built retail space can qualify for ICAP benefits. Abatements can last as long as 25 years in some cases and protect a developer from the large increases in value (and consequently, real estate tax assessments) that normally results from these large development projects. There are complex filing procedures and requirements to be met and maintained during the duration of the project in order to qualify for the benefit, including minimum required expenditure amounts and requirements for soliciting Minority and Women-Owned Businesses (MWBE) for the work being done.
  • 420 Benefits. This program provides various tax abatements/exemptions for properties owned by charitable and not-for-profit entities. There are initial requirements that must be met and substantiated in order to qualify as well as certification of continuing charitable or non-profit use in order to ensure the benefits remain in place each year.
  • J-51Program. This program provides a property tax exemption and abatement for renovating and upgrading residential apartment buildings. The benefit varies depending on the building’s location and the type of improvements.
  • 421-a Program. In April, 2017 legislation was signed amending and replacing the previous 421-a program to create the new Affordable New York Housing Program. This program applies to new construction of multi¬family residential buildings and eligible conversions and provides eligible projects with substantial tax savings, in some cases up to 35 years of real estate tax abatements (in addition to a three year abatement during construction).       To benefit from the tax savings, some significant requirements must be met - for example, all projects must be comprised of at least 25% affordable units. For projects located in specific areas and comprised of more than 300 units, certain wage requirements for construction workers also apply. The program applies to both rental and condominium/co-op projects though the eligibility for condo/co-op projects has more restrictions. (3) This new version of the 421-a program applies to eligible projects that commence between January 1, 2016 and June 15, 2022. As of May, 2017, the law is brand new and there are nuances that will likely need to be resolved by the City in its rule making process, however, the key point is that this benefit for new residential projects will once again be available to developers.
  • Exemptions for Individual Homeowners. Many individual home and apartment unit owners may qualify for certain property tax reductions pursuant to programs such as the cooperative/condominium abatement, School Tax Relief Program (STAR), Senior Citizen Exemption, Disabled Homeowners Exemption, Veterans Exemption, and Clergy Exemption. Applications for benefits must be made annually as changes in circumstances (i.e., transfers) each year may take a unit out of eligibility for the various programs.
  • Progress Assessments. While not part of any formal exemption or abatement program, New York City law does allow for some tax relief for the construction of new commercial and residential buildings. It is a general rule of assessment in the City that a building in the course of construction, commenced since the preceding fifth day of January and not ready for occupancy on the fifth day of January following, shall not be assessed unless it shall be ready for occupancy or a part thereof shall be occupied prior to the fifteenth day of April. All newly constructed commercial and residential buildings are entitled to at least one year of this so-called “progress assessment” whereby any building assessment placed on the property would be removed. With the exception of hotels, new commercial buildings can actually get up three years of progress assessments while in the course of construction if the building is not ready for occupancy each April 15. This essentially allows for up to three years of no building assessments while in the course of construction.

The programs noted above are important for counsel to be aware of. When representing an owner, any discussion regarding major construction projects and changes to a building should be considered in the context of potential availability of some of these benefit programs. They can play a huge role in reducing an owner’s tax burden and making contemplated projects more economically feasible. Similarly, counsel representing a purchaser should be aware of any plans the purchaser may have as far as construction and/or converting the nature of the building (i.e., from commercial to residential) as these types of changes have substantial property tax ramifications as well as potentially substantial benefit programs that may help mitigate potential increased liability.

Tax Certiorari Lease Provisions/Exemption Lease ICAP Provisions

Real estate taxes in New York City are becoming an increasingly large portion of landlords’ and tenants’ investment calculations and it is vital to account for real estate tax issues in commercial leasing. Determining whether a landlord or a tenant is responsible for payment of the taxes and who has the right to challenge the taxes is just one issue. Tax escalation clauses and how payments are spread among the tenant and the landlord, as well as choosing an appropriate base year from which said real estate tax escalations begin, are essential components to any commercial leasing negotiation and often make or break deals.

Knowledge of assessment procedures and DOF calendars for when rental figures will be used in assessments is vital in determining base year real estate tax payments and how increases in tax payments are to be determined on a going-forward basis. These issues must also be accounted for in commercial leases. Finally, provisions regarding which party benefits from any abatement programs (if applicable) need to be negotiated in any lease.

This will certainly affect overall rental and tax payments. Many negotiated real estate transactions hinge on real estate tax projections going forward. Projecting future real estate taxes is fraught with uncertainty. However, with comprehensive knowledge of how the system works, one can make reasonable estimates. It is these estimates and projections that are frequently the basis for lease negotiations. Specialized real estate tax counsel may be retained to assist in these projections and to review drafts of leasing documents.

Conclusion

At the very least, when entering into a real estate transaction involving property in New York City, counsel should be aware of New York City’s complex real property tax process and how the issues surrounding that process may affect his or her clients. The process of challenging property taxes involves a complicated assessment procedure system on the part of the City as well as multiple required filings throughout the course of the year, which must be complied with in order to even have the opportunity to challenge one’s assessment.

An understanding of the assessment process, how real estate taxes are calculated, and the benefit programs the City makes available to property owners will allow counsel to better negotiate on behalf of clients. Failure to accurately and meticulously account for the increasingly important role that real estate taxes play will put counsel at a major disadvantage.

Tishco image

Steven Tishco is an associate at Marcus & Pollack, LLP. Mr. Tishco concentrates his practice on real estate tax assessment and exemption matters (tax certiorari). He handles all types of real estate tax disputes and appears regularly before the Courts of the State of New York and various New York City agencies. His experience includes litigation and trial work involving the valuation of residential and commercial properties.  The law firm of Marcus & Pollack LLP, is the New York City member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.

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Jun
10

Presentation at Appraisal Institute and Appraisal Institute of Canada Annual Conference

Summary

The logical and proper valuation of big box stores for assessment purposes is not based on the income stream. We believe the cost approach with adjustments for obsolescence is the most satisfactory methodology. This conclusion was arrived at after lengthy discussions and negotiations amongst appraisers that took place outside the usual litigation environment, subject to the supervision of legal counsel and overriding purview of the Assessment Review Board in Ontario.

We examined the current value assessments of 162 big box freestanding stores in the Province of Ontario owned by a single operator. There were outstanding assessment appeals by the taxpayer for the 2008 base year (2009-2012 taxation), and the 2012 base year (2013-2016 tax years). Most significantly, we settled those appeals on the basis of the cost approach, including going forward to the 2016 base year (2017-2020 tax years).  The settlement process began in 2013 and resolution was achieved in 2016.

Background

Big box stores are large discount stores, including WalMart, Home Depot and our own Canadian Tire. These stores generally exceed at least 40,000 square feet in area. Unlike most property types, the buildings are built to suit or custom built for a specific retailer’s business. The boxes are not built on a speculative basis to be sold or leased in the marketplace after development.

Upon sale of the fee simple interest in the big box store, the original use may be modified for the new user, or the building may be demolished. Such stores are rarely purchased to be leased by a single tenant after the purchase (for retail purposes or otherwise).

There has been much litigation in the United States relating to the big box store valuation conundrum.  Kennard and Fisher asked:

“. . . if it cost $70.00 per square foot to build an anchor department store, then why is it they sell for about half of their replacement cost new?”

This question led, in part, to the so-called “dark store” theory of valuation which resulted in numerous decisions of courts and tribunals concluding that the sales comparison approach, based on market sales of the big box store resulted in an objective determination of market value. Invariably these sale prices were substantially less than the cost to construct. Application of the “dark store” theory has devastated assessments of big box stores in many American jurisdictions.

In Ontario, the assessment standard is “current value”. Current value in essence means the same as what you might know as fair market value, or appraised value, or actual value.  Current value is defined in the Assessment Act as follows:

“Current Value means in relation to land, the amount of money the fee simple, if unencumbered, would realize if sold at arm’s length by a willing seller to a willing buyer.”

There has been much litigation in the Province of Ontario as to the meaning of current value. It is clear that this valuation standard is an objective, market based concept.

The value to the owner, or the subjective value of the real estate, is irrelevant for assessment purposes. The statutory standard of value is based on objective analysis of data from the marketplace. The identity of the occupant is not relevant.

Historical Reliance on Income Approach

“An appraisal is the logical application of available data to reach a value conclusion.” (borrowed from William Kennard)

The data showed that these big box properties are never built speculatively and then put on the market for rent or sale. Once the property is rented by the developer to a retailer, the real property may be sold from investor to investor. Generally the developer and the retailer are either related or the same person. The attractiveness of the purchase to investors is a function of the lease amount – rent amount, terms and quality of tenant – rather than the fee simple interest in the real estate.

Frequently the developers/retailers sell the real estate for financing purposes, and lease it back.

Sales-leasebacks are financing arrangements rather than pure fee simple real estate transactions. Sales of real estate occupied by a long-term tenant reflect the value of the leased fee of the real estate and, implicitly, the quality of the tenant. However, for assessment purposes we are searching for the fee simple value – not the leased fee interest.

Municipal assessments in Ontario are undertaken by a single corporation collectively owned by all the municipalities – MPAC. The three statutory parties to the appeals are the property owner (ie. the taxpayer), MPAC and the municipality in which the property is located.

Notwithstanding the above concerns regarding the income approach, Ontario big box stores had been valued by assessors using an income approach with rents derived from available financing transactions. The basis for determining market rent was a mystery. The capitalization rates relied upon by the assessor seem to have been drawn from sales of shopping centre regional malls. Frequently, the rents applied by MPAC were nothing more than the previous base year’s economic rent indexed to the next base year. The number of open- market lease transactions available was extremely limited and, therefore, data extracted to support the appraised value came from a very shallow pool. The assessed values were based more on hokum-pokum than objective data reflective of a true market.

To a great extent, historically the resolution of assessment appeal litigation with MPAC regarding big box stores in Ontario was based upon comparability and equity as between similar properties. Eg. Is a WalMart store worth $1 per square foot less than Home Depot? Is the Toronto market for big box stores worth $2 per square foot more than in Ottawa?

2008 Base Year

In order to prepare for the 2008 CVA reassessment, the Municipal Property Assessment Corporation (“MPAC”) determined a scale of fair market rents applicable to big box retailers based on the name of the occupant and “bench marking” of rents according to market area (ie. land values) and notional base rents for WalMart stores. An extract from that analysis produced by MPAC is set out below:

Market Area (b) 500,000 – 750,000 per acre – Regions 3, 13, 16, 19, 21, 22

Tenant

Base Rent

Adjustment

Final Rent

Comments1

WalMart

$11.00

0

11.00

Base benchmark rent

CTC

$11.00

+0.50

11.50

Base + 0.50 – higher building cost2

Lowes

$11.00

+1.00

12.00

Base + 1.00 – higher building cost2

Home Depot

$11.00

+1.00

12.00

Base + 1.00 – higher building cost2

Rona

$11.00

+1.00

12.00

Base + 1.00 – higher building cost2

Costco/Sams

$11.00

+1.25

12.25

Base + 1.25 – higher building cost3

1 Adjusted rate may be further adjusted if effective age greater than 20 years.

2 Higher buildings = higher building costs

3 Plus 0.24 for coolers and freezers

We commenced the appeals litigation with the assertion that the income approach utilized by MPAC was invalid because there was insufficient data regarding fair market rents available to support it. The taxpayer relied upon the cost approach as the most appropriate measure, conditional upon a full measure of obsolescences being accounted for in the valuation process.

Although we left open the option of referring to the “dark store theory”, that path was not pursued. The expectation was that a settlement could be negotiated using the cost approach with appropriate adjustments for obsolescence. It was also our view that the scorched earth results of the dark store theory were based on a faulty assumption regarding non-compete clauses registered on title for the big box stores.

The Settlement Process

In 2013, negotiations began between MPAC and the big box property owners.

The big box operators had retained the services of appraisers familiar with assessment practices. MPAC similarly directed experienced appraisers within its organization to grapple with the appeals. Counsel for both the taxpayers and MPAC agreed to suspend ordinary litigation proceedings and litigation tactics to permit an open and frank exchange of views between the parties, in particular amongst appraisers without counsel present. Counsel for both the property owner and MPAC agreed from the outset that full disclosure of information and candid, without prejudice exchanges of opinions amongst the appraisers would be the hallmarks of the negotiations. Furthermore, counsel agreed that the consensual results of the appraisal discussions would guide the terms of settlement of outstanding appeals and future assessments.

As part of our negotiations, and after an initial state of discussions, MPAC and the property owner invited municipal representatives to form a Municipal Working Group (“MWG”) and participate in the negotiations.  The MWG included seven (7) representatives from some of the affected municipalities. Each representative signed an undertaking of confidentiality and non- disclosure.

As a prelude to those negotiations, MPAC and the property owner issued a Joint Communique to the MWG, which became the starting point for negotiations. The Joint Communique provided a current status report of the initial negotiations, which included the following statements:

  1. MPAC and the taxpayer have agreed that the cost approach is the most reliable determinant of current value for these properties.
  2. MPAC and the taxpayer have agreed that the appropriate approach to determine economic life of the buildings is the market extraction method.
  3. MPAC and the taxpayer have agreed that the MPAC automated cost approach to determine RCN of the buildings overstates actual construction costs.
  4. MPAC and the taxpayer are reviewing 300 land sales and the assessments of approximately 600 comparable land parcels to respond to municipal concerns that land values may have been understated in the comparative sales analysis.

The property owner and MPAC invited the MWG to review and challenge the various data files and analyses undertaken jointly by the property owner and MPAC.  In 2016, the property owner and MPAC entered into a Memorandum of Understanding as to principles for resolution of outstanding appeals for 2008 and 2012 base years, and the principles for assessment going forward with the 2016 CVA reassessment. The Memorandum of Understanding was endorsed by the MWG.

The Memorandum of Understanding was widely distributed to the municipalities, and published in the Canadian Property Tax Association’s monthly newsletter as an article authored by an MPAC officer. A copy of that article is attached.

The result of this process has been to resolve two cycles of assessment appeals (2008 and 2012), and to set in place assessment principles for the 2016 cycle.  The process was based on three elements not commonly found in assessment appeals:

  1. Candid and transparent disclosure of information, on a multi-party basis.
  2. Involvement of municipalities relatively early in the appeal process to provide a forum for their concerns and understanding.
  3. Most importantly, establishing a protective zone where appraisers could meet, share data, exchange views and analysis, all without tactical advocacy of their respective client’s interests.

In summary, the participants in the process found success when:

  1. Legal counsel provided interest based general counsel to their respective clients and facilitated the process, rather than simply litigating conventionally.
  2. Appraisers appraised with open minds, rather than advocating for or against the status quo.
  3. Trust and patience was maintained, even when unexpected developments created log-jams, hurdles or delays.

In other words, the appraisers were not advocates, and legal counsel were not experts.  The result was a happy resolution to a thorny assessment problem.

J. Bradford Nixon

Brad Nixon is a Member of the law firm Nixon Fleet & Poole LLP which has an office in Toronto, Canada.  The firm is the Canadian member of American Property Tax Counsel. Brad can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.                                       

 

 

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May
31

Tax Exemptions Draw Scrutiny

Owners face hidden pitfalls when applying for commercial property tax exemptions.

Municipalities are taking a hard look at real estate tax exemption applications, hoping to offset revenue losses stemming from a rash of successful assessment challenges.

It’s unsurprising that taxpayers are mounting protests in record numbers, considering the dollars at stake. Commercial real estate taxes in the Northeast are among the highest in the nation, and the high cost of living in the area compounds the financial pressure on property owners. That also explains why many property owners are seeking relief from those costs by applying for exemptions.

Most states provide an avenue which exempts religious, educational and not-for-profit entities from the payment of real estate taxes. Some states, such as Maine, limit tax exemptions to a dollar amount. Others including Rhode Island impose a property size limitation, while some states have no discernible limits on the property size or exemption amount, which is the case in New York. Despite these limitations, tax exempt applications represent a significant loss of potential tax revenue for a municipality.

To qualify for the tax exemption, each state has its own application, which must be filed with the proper agency, typically the assessor or assessment department. Many states require taxpayers to file a new application each year, along with supporting documentation.

Once submitted, there are three possible outcomes: The application may be granted in full, meaning the property is 100 percent exempt from real estate taxes; it may be granted in part, meaning only a portion of the property will receive tax-exempt status; or it may be denied.

Provided the exempt organization is operated exclusively for the purposes specified in its enabling statute, and the entire property is wholly used for its specified purpose and no profit is made by the property owner, the application should be granted. Many courts have determined that all parts of the exempt property must be used in connection with its exempt purpose to qualify for a 100 percent exemption. Any property not utilized in this respect will be placed back on the assessment roll.

If a building or portion of the property is not being used or is vacant, the property may still qualify for the exemption, provided that a clearly defined plan is in place to utilize the property in the near future for exempt purposes. Construction plans, grading of the property, renovations and the like would  satisfy this requirement.

In recent practice, these three conditions have been strictly interpreted, with municipalities seizing every opportunity to place previously tax-exempt property back on the assessment roll.

Praying for Relief

Recently, a small yet nationally recognized church of about 75 congregants in New York needed to retain legal counsel to defend its tax-exemption application. The 13-acre property was improved with a number of free standing buildings used for administration, housing for the pastor and places of worship. The church had owned the property for decades and always received a 100 percent tax exemption.

Sometime in the winter of 2015, a pipe not properly winterized burst in one of the buildings. The property flooded and sustained considerable damage. To save on renovation costs, the church and its members took on the repair of the building themselves. The church’s subsequent application for the real property tax exemption duly related this information, and as a result, the application was denied in part.

The municipality reasoned that because the building was now vacant and not being used for an exempt purpose (it could not be used while under renovation), it was no longer entitled to tax-exempt status. The taxing entity placed the property back on the assessment roll and issued a tax bill totaling more than $100,000.

The church did not have the funds to pay, and faced the distinct possibility of foreclosure and the loss of the property by tax lien sale. Negotiations by the local attorney for the reinstatement of the 100 percent tax exemption stalled. Ultimately, the church successfully challenged the partial denial in court via motion for summary judgment.

Tax-exempt Lessees

Problems can also arise when a privately owned property is leased to a tax-exempt entity seeking a tax exemption. In other words, would a taxable building be entitled to an exemption based on a lessee’s status as an exempt entity? The answer is unequivocally “no.”

New York Real Property Tax Law 420(b)(2) carves a limited exception to the above, however. If a for-profit entity that owns a property leases the entire parcel to a non-profit, the only time the property would be entitled to tax-exempt status would be if any money paid for its use is less than the amount of carrying, maintenance and depreciation charges on the property. However, the terms “carrying charge,” “maintenance charge and “depreciation charge are undefined in the statute.

Nevertheless, courts have interpreted carrying charges as outlays necessary to carry or maintain the property without foreclosure, such as insurance, repairs and assessments for garbage disposal, sewer, and water services. Amortization of mortgage principal for these purposes should be excluded from carrying charges, as should corporate franchise taxes, which are crucial to the corporation’s existence but not to the maintenance of the building. Legal expenses for the collection of rent or penalties and late fees should also be excluded.

Maintenance charges include costs to maintain and repair the property. They may not include enhancements that increase the property’s value, replacements that suspend deterioration, or changes that appreciably prolong the life of property.

Depreciation can be defined as a decline in property value caused by wear and tear, and is usually measured by a set formula that reflects these elements over a given period of useful property’s life.

Clearly, while real property tax exemptions are becoming more popular, potential applicants would be wise to contact an attorney or expert familiar with applicable statutes and case law before submitting an application for property tax exemption.

 

Jason Penighetti 217x285Jason M. Penighetti is an attorney at the Mineola, N.Y., law firm of Koeppel Martone & Leistman LLP, the New York State member of Amercian Property Tax Counsel, the national affiliation of property tax attorneys.  Contact Jason at This email address is being protected from spambots. You need JavaScript enabled to view it.

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May
30

Utah Tax Sales Require Due Process

State Supreme Court finds that due process error bars statute of limitaitons on title challenge.

The Utah Supreme Court has affirmed the right of property owners to challenge tax sales conducted without constitutionally adequate notice to the property owner, even when the challenge takes place after the prescribed statutory limitations period has expired.

The court’s Jan. 10, 2017, decision in Jordan vs. Jensen overruled its 1955 decision in Hansen vs. Morris, where it had held that once the limitations period had passed, the purchaser of a tax deed could retain title against a challenge from an earlier deed holder even when the tax sale had violated due process.

The case centered on the question of whether or not a taxing entity’s failure to provide adequate, constitutionally required notice to an interested party of a tax sale prevented the application of a statute of limitations specific to tax title challenges.  Utah law prohibits parties from challenging a tax title holder’s ownership of real property more than four years after the property was conveyed.

In Jordan vs. Jensen, the property at issue was sub-surface mineral rights that had been severed from the surface interests in 1995. The owner of the surface estate failed to pay property taxes between 1995 and 1999, and Uintah County seized the property and sold it in a tax sale in 2000. The purchaser of the tax deed then sold the property to the Jensens.

The Jordans were the owners of the severed mineral interest and neither they nor their predecessors had ever received notice of tax assessments for the mineral estate, nor did they receive notice of the surface owners’ failure to pay taxes or of the tax sale. Although the mineral interest had been severed from the surface interest in 1995, the 2000 tax deed purported to convey the land without reservation or exceptions.

A lessee of the Jordans’ mineral rights secured two title opinions in an effort to ensure that the Jordans actually owned the leased mineral interests. Both attorneys expressed their concerns that the mineral estate might have passed to the Jensens under the tax deed.

When the Jordan's became aware of the title concerns in 2013, they asked the Jensens to sign a mineral rights quitclaim deed to settle the issue. The Jensens responded by claiming ownership of the mineral estate for the first time.

The Jordans filed a complaint to quiet title, alleging that the mineral interest could not have passed as a result of the tax sale because the Jordans never received notice of the sale. The Jensens counter-claimed, seeking title to the mineral interest and alleging that the Jordans’ action was barred under Utah’s judicial code because more than four years had passed since the tax sale.

In the code’s chapter on statutes of limitations, Section 206 prohibits a party from challenging conveyance in a tax sale after the passage of four years, as follows: “An action or defense to recover, take possession of, quiet title to, or determine the ownership of real property may not be commenced against the holder of a tax title after the expiration of four years from the date of the sale, conveyance, or transfer of the tax title to any county, or directly to any other purchaser at any public or private tax sale.”

The Jensens invoked this provision in defense against the Jordans’ action to quiet title, claiming that inasmuch as the tax sale had occurred more than four years prior to the lawsuit, the Jordans could not challenge the validity of the tax sale. The Jensens argued that the tax sale would have been voidable for failure to provide notice within the four-year period, but that the limitations period protected the tax title from legal challenges after that time.

Both parties filed motions for summary judgment. Neither disputed that the county failed to provide constitutionally adequate notice of the sale. Therefore, the only issue was whether that deficiency prevented the application of Section 206.

The district court held that the four-year limitations period did not apply because the county had violated constitutional requirements of due process by not providing notice to the Jordans of the tax sale, and that failure prevented the mineral interest from passing at the tax sale. The Jensens appealed the district court’s decision to the Utah Supreme Court.

On appeal, the Jensens relied on Hansen v. Morris (1955), wherein the court rejected a due-process challenge to the predecessor to Section 206. In that case, the Utah Supreme Court  held that the application of the four-year limitations period was constitutional even when “statutory steps required to perfect a tax title have not been taken, such as failure to give notice of sale, failure of the auditor to execute affidavits, etc.

The Jordan court acknowledged that the Hansen court had rejected a due-process challenge to the application of Section 206, but found that three subsequent United States Supreme Court decisions required reversal of Hansen.

In Mennonite Board of Missions vs. Adams (1983), state law provided a two-year redemption period after a county tax sale. However, the U.S. Supreme Court held that the mortgagee was deprived of due process and the two-year limitations period did not apply because the mortgagee had not received notice of the tax sale.

In Schroeder vs. City of New York (1962), a statute required an aggrieved party to sue for damages within three years after the city diverted water. Schroeder sued more than three years after diversion had occurred, but the court held that the limitations period did not apply because the city had not given Schroeder notice that it had diverted the water.

In Tulsa Professional Collection Services Inc. vs. Pope (1988), the court held that non-claim statutes requiring creditors to submit claims to the executrix within two months were limitations periods that required actual notice before they could bar a creditor’s claim.

According to the Utah Supreme Court, these U.S. Supreme Court. cases established that “a statute providing a limitations period will not apply when it is triggered by constitutionally defective state action.” There was no dispute that the Jordans had not received constitutionally sufficient notice of the tax sale, or that the tax sale constituted state action. Thus, the court held that the Jordans had the right to challenge the Jensens’ claim to title in the mineral interest and that “the county’s failure to provide notice prevented the Jordans’ mineral interest from passing at the tax sale.”

Stephen Young Sept 2014Hunsaker Pamela

Steven P. Young, Partner and Pamela B. Hunsaker, Of Counsel, serve the Salt Lake City law office of Holland & Hart which is a Montana, New Mexico, Utah and Wyoming member of American Property Tax Counsel, the national affiliation of property tax attorneys. 

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May
25

Property Tax Tip: Beware of Misleading Comp Sales

Are you challenging an assessment?  

A veteran tax attorney urges a close look at sales comps used by the assessor, which may not reflect your asset's true market value.

To estimate a property’s value for taxation, assessors customarily draw on in-house databases.  Sales chosen for comparison are selected on the basis of general characteristics, such as location, use and zoning.

However, those characteristics do not tell the entire story. To begin with, databases are neither designed nor maintained to record crucial details. Although buyer motivation is assumed to be implicit within the transaction that information is rarely included, if ever.

In practice, no two property sales are identical. In order for the assessor to draw value conclusions, comparisons must reflect adjustments for the unique characteristics affecting the price. A real property transaction may meet one standard of a market sale: the arm’s-length test, which establishes that the buyer and seller are independent and acting in their own interest.

FINDING THE MOTIVE

Nevertheless, the taxpayer must examine the buyer’s motivation, which may very well turn out to disqualify the transaction as a comparable market sale. If the buyer’s needs are unique to that transaction, reflecting a motive that other investors are unlikely to share or value, that disqualifies the exchange as a valid transaction for comparison.

The assessor’s records should include such basic information as the buyer and seller, the property’s size and location and the closing date. This provides a starting point for further inquiry.

In many instances, the needs of the seller or buyer create an exchange value unique to the parties and do not reflect market value. They may include one or more of the following situations.

Strategic premium. The buyer under this scenario is protecting its own enterprise by eliminating opportunities for competitors to move into its trade area. An owner of convenience stores that sell gasoline, for example, may acquire sites likely to attract other operators, impose deed restrictions that preclude competition, and resell the restricted property. To that convenience-store owner, the value of the deal is to enhance sales volume by eliminating competition. Other categories of retail chains may employ the strategy. One big-box retailer typically imposes deed restrictions on sites it vacates, thus thwarting competitors from moving into its former space.

Part of a larger deal. The assignment of value within a portfolio transaction is always subject to question. When investors buy multiple properties in a single deal, they may be compelled to take on some under-performing assets along with the most desirable ones. For that reason, values assigned to individual assets in the transaction may be arbitrary, or at best driven by other priorities, not the least of which may be depreciation schedules for federal tax purposes.

Unique buyer needs. A business that must expand its footprint to keep growing has two choices: Buy the property next door, or move to a larger location. The value of the neighboring property to that buyer does not necessarily reflect how the market would typically value the property, but indicates only the buyer’s need at that time.

Sale-leasebacks. The transfer of a property with a leaseback agreement is more a financing arrangement than a conventional sale. It generates cash for the seller and returns to the buyer through lease payments that may bear little or no relation to actual market lease rates. The value in exchange lies in the entirety of the arrangement, which is essentially equivalent to a loan secured by a deed of trust that includes outside collateral.

Assemblage. In order to create a parcel large enough to meet its needs, a buyer may acquire several tracts to create a single property. The individual parcels cease to exist separately and become an undefined part of the new, larger assemblage. Sometimes the owner of the key tract—perhaps the final one required to complete the assemblage—is able to extract a higher price than the property would otherwise command. To the buyer, it is a must-have piece without which the project cannot be completed. Since the buyer pays more than the market value, the excessive price is an unreliable barometer.

These examples demonstrate that the values an assessor references as comparable purchase prices may well be misleading. Indeed, the prices paid for those assets regularly stem from strategic priorities, rather than from actual market. By carefully examining the assessor’s database of comparable sales, taxpayers can reduce property assessments that do not reflect the fair market value of a property.

 

Wallach90Jerome Wallach is the senior partner in The Wallach Law Firm based in St. Louis, Missouri. The firm is the Missouri member of American Property Tax Counsel, the national affiliation of property tax attorneys. Jerry Wallach can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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May
01

Invalid "Dark Box" Property Tax Claims Misinform Indiana and Michigan Legislatures

Some have recently called this the dark box theory. However, what some are now calling the dark box theory is simply traditional accepted valuation methodology. Indeed, among appraisal professionals, it is the use of comparable sales of occupied stores that generates controversy and is often inappropriate to value an owner-occupied store.

If the criticisms of valid appraisal methodology are not legitimate, why has this issue received so much attention? One cause is the financial pressure on localities due to lower property values from the Great Recession. Not only did property values fall after 2008, but many businesses closed altogether. Communities have faced not only a loss in jobs but also decreasing property values. In both Michigan and Indiana, that pressure was compounded by the application of property tax caps. Public coffers to support local services have been squeezed, and state governments have not provided additional funding.

Another root cause was self-inflicted: the unjustified, over-assessment of new big box stores. Assessors used construction costs and land cost as the “market value” of the property, despite the fact that, like a new car or a newly tailored suit, the market value of these properties is always less than the cost of construction.

The purported problem is also one of public perception. If a retail store is operating, with inventory on the shelves and customers in the aisles, it may be difficult for the general public and local officials to understand why it is appropriate to value the property by using a transaction of a similar store that was vacant at the time of sale.

Trained assessors, however, should know better. They are legally required to only value the property itself, i.e., its “sticks and bricks” as well as the land. The occupants and content of the property have no relevance to the market value of an owner-occupied real property. Most states separately tax the business activity conducted on a property through income and sales taxes. Assigning value to property based on a taxpayer’s business operations will unlawfully tax properties based on both intangible assets and intangible factors, and result in nonuniform taxation of similar properties.

Indiana Board of Tax Review Decisions
In December of 2014, the Indiana Board of Tax Review (IBTR) issued two opinions, which in most respects were no different than hundreds of rulings that preceded them.In both cases, taxpayers prevailed after the IBTR concluded their USPAP-compliant appraisals represented the best evidence of value. In the first case, involving a freestanding 237,000 square foot big box store in Indianapolis, the taxpayer’s appraiser developed and relied upon the sales comparison and income approaches to value (assigning more weight to the sales approach) to reach value conclusions for multiple tax years. In the second case, involving an 88,000 square foot big box store attached to a shopping center, the taxpayer’s appraiser developed all three approaches to value but relied on and assigned equal weight to the sales comparison and income approaches to value.

In both cases, the taxpayers’ appraisers used sales of vacant stores. Each appraiser adjusted those sales to reflect the differences between the appraised store and the comparable stores. Neither appraiser relied exclusively on the sales comparison approach to value. Consequently, the IBTR’s rulings in both appeals were not based solely on the supposed “dark box” sales, and the sales that were relied upon were adjusted to reflect differences between the subject and the comparable properties, with respect to physical condition, location and other factors.

That nuance was lost on the assessing community as a whole and the subsequent statewide media reporting. The public was told that the IBTR incorrectly compared an active store with a defunct one. Yet, a sale of a vacant store represents the transfer of the real property alone, without the value of the business operations, which is exactly what should be valued under the law. The flawed and overly simple criticisms of the IBTR’s decisions were repeated often, and loudly. Unfortunately, the Indiana General Assembly listened.

The Indiana Legislative Reaction and its Subsequent Fallout 2015 Legislation
After much heated discussion, the Indiana legislature, in the waning hours of its 2015 session, passed two provisions addressing “dark box” assessments in Senate Bill 436. The first provision (Section 43) was directed at big box stores. Assessors were directed to assess newer stores (those with an effective age of ten years or less) using a modified cost approach, accounting for physical depreciation and obsolescence.

The second provision (Section 44) impacted all “commercial non-income producing real property, including a saleleaseback property.” In determining the true tax value of qualifying properties with improvements with an effective age of ten years or less, a “comparable real property sale” could not be used if the comparable, among other restrictions, had been vacant for more than one year as of the assessment date.

Sections 43 and 44 were not well received. The IBTR issued a memo noting the new law contained “provisions that run counter to generally accepted appraisal practices.”

2016 Legislation
Indiana’s 2016 legislation session saw a complete repeal of Sections 43 and 44, effective January 1, 2016. House Bill 1290, Section 13, added Ind. Code § 6-1.1- 31-6(d) to provide: “With respect to the assessment of an improved property, a valuation does not reflect the true tax value of the improved property if the purportedly comparable sale properties supporting the valuation have a different market or submarket than the current use of the improved property, based on a market segmentation analysis.” Any such analysis “must be conducted in conformity with generally accepted appraisal principles.” And the analysis “is not limited to the categories of markets and submarkets enumerated in the rules or guidance materials adopted” by Indiana’s property tax rulemaking agency, the Department of Local Government Finance (DLGF), which is the agency that was directed to develop rules classifying improvements in part based on market segmentation.

What does this mean? That remains to be seen. Subsection 6(d) will undoubtedly be litigated before the IBTR and Indiana Tax Court, and the DLGF is in the process of developing its market segmentation rules. We do know two things: (i) the party challenging use of comparable sales must provide the market segmentation analysis; and (ii) the analysis must be based on generally accepted appraisal principles. No presumption exists under the statute that a sale is excluded. Exclusion must be proven with expert analysis.

Subsection 6(d) will lead to more costly appeals, with additional expert testimony and reports on market segmentation being required. As appeal expenses increase, litigants are likely to adopt tougher settlement positions, which will cause fewer cases to settle. As litigation takes longer to resolve, local officials’ uncertainty regarding the tax base will also increase. Section 13 also added Ind. Code § 6-1.1- 31-6(e), which cemented a long-standing principle of Indiana assessment law, i.e., that true tax value “does not mean the value of the property to the user.” To illustrate, the assessed value of a big box store owned and operated by Wal-Mart cannot be based on the specific value that the store has to Wal-Mart due to, for example, how Wal-Mart uses its unique marketing and employee training standards to sell its distinctive product mix.

Proposed Michigan Legislation – HB 5578
As in Indiana, Michigan government representatives have been waging a public relations campaign that has misled the public, including policy makers. The legislation drafts originally circulated were influenced by Indiana’s legislation. Ultimately, on June 8, 2016, the Michigan House passed House Bill 5578 (“HB 5578”). Among its many significant flaws, HB 5578 prevents use of the sales comparison approach in cases where its use would be appropriate, and forces reliance on the cost approach, without accounting for all forms of obsolescence. It is not yet known what will happen to the bill in the Michigan Senate.

HB 5578’s Required Findings of Fact
HB 5578 requires many specific findings of fact by the Michigan Tax Tribunal in a tax assessment appeal. Among others, HB 5578 requires specific findings of fact regarding: the market in which the subject property competes, the highest and best use of the property under appeal, the reproduction or replacement cost, and comparable properties in the market that have the same highest and best use.

While the listed factors are appropriate to consider in a valuation appeal, requiring specific findings of fact will be extremely burdensome and, in some cases, is ambiguous or unworkable. For example, an automotive assembly plant in Michigan might compete with automotive plants in the Midwest, Canada and Mexico and the automobiles produced at the plant could be shipped worldwide. HB 5578 provides no ascertainable standards on how one determines “the market in which the property subject to assessment competes.”

HB 5578 requires calculation of a “replacement or reproduction cost for property that has the same . . . age as the property subject to assessment.” It is nonsensical to calculate the construction cost to reproduce or replace property that has the same “age” as the property under consideration because, as an example, one cannot construct a 40-year old building. Presumably, what was intended was that cost new would be calculated, with a deduction for the depreciation of the subject property due to age. However, that is not what the plain language of HB 5578 requires.

HB 5578’s Exclusion of Comparable Properties
HB 5578 requires that a comparable property be excluded if its “use” is different than the highest and best use of the property subject to assessment. It is unclear what the term “use” means as applied in this subsection and whether it means “actual use when sold,” “subsequent use after sale,” or “highest and best use when sold.”

The proposed legislation also allows a comparable property to be considered “if the sale or rental of the property occurred under economic conditions that were not substantially different from the highest and best use of the property subject to assessment unless there is substantial evidence that the economic conditions are common at the location of the property subject to assessment.” This provision is absurd. It is impossible to compare “economic conditions” with “highest and best use” and, even if it were possible, it would not make any sense to do so.

For the sale of a comparable property that was vacant at the time of sale, HB 5578 requires consideration of whether “the cause of the vacancy is typical for marketing properties of the same class.” How is a “cause of vacancy” ever “typical for marketing”? HB 5578 further requires consideration of whether “the vacancy does not reflect a use different from the highest and best use of the property. . . .” Conspicuously missing from HB 5578 are any instructions as to the determination of how a vacancy reflects a use.

HB 5578 requires exclusion of a comparable sale property if the comparable property was subject to a deed restriction or covenant, “if that restriction or covenant does not assist in the economic development of the property, does not provide a continuing benefit of the property, or materially increases the likelihood of vacancy. . . .” What is missing from this analysis is any consideration as to whether such a deed or covenant would impact the price at which the property sold. For example, a reciprocal easement on the comparable property that did not “assist in the economic development of the property” but did not impact its sale price likely would be enough to exclude the comparable sale. Such reciprocal easements are commonplace and generally do not affect the price at which property sells.

Conclusion
Few would challenge the fundamental principles that property tax assessments should be uniform and should reflect the value of the fee simple interests of the properties – not the values of the business operations conducted thereon. Yet, the “dark box” bogeyman threatens these cornerstone valuation principles. In both Indiana and Michigan, new legislation gives taxpayers good reason to fear that in future years they may be faced with inflated property tax bills based on non-uniform and inequitable assessments.

 

Brent AuberryBrent A. Auberry is a partner in the Indianapolis office of the law firm Faegre Baker Daniels LLP, the Indiana member of American Property Tax Counsel (APTC), the natonal affiliation of property tax attorneys. Mr. Auberry can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it.

 

Mandell StewartStewart Mandell is a Partner of the Tax Appeals Practice Group Leader, in the law firm of Honigman Miller Schwartz and Cohn LLP, the Michigan member of American Property Tax Counsel (APTC). He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

 

Daniel L. StanleyDaniel Stanley is a Partner in the law firm of Honigman Miller Schwartz and Cohn LLP, the Michigan member of American Property Tax Counsel (APTC). He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Apr
26

Add Value Through Correct Valuation

Even in a booming market, managing expenses is the best way to ensure the long-term profitability of investment properties. For most student housing, the largest expense after debt service is property tax.

Assessors in college towns are happy to shift the tax burden onto out-of-town students and investors in student housing communities. And due to the perplexing assessment systems in most jurisdictions, owners and developers of student housing communities often treat tax assessments as a given, making appeals the exception rather than the rule. Yet any reduction in the tax burden can substantially increase profitability, so prudent owners monitor tax assessments closely.

Most ad valorem tax disputes hinge on property value. Developers are adept at valuing assets for investment, but there are substantial differences between taxable value and how much a property is worth as an investment. Knowing these differences can protect owners from overzealous assessors.

Identify the right income

Because student housing communities are income-producing properties, developed and purchased for the high-quality income streams they generate, most assessors argue that capitalized income is the best indication of their real estate value. Accordingly, assessors often ask for the property’s historic income and expense information. Taxpayers should be hesitant to provide the property’s operating statements without considering appropriate caveats, however.

In most states, property tax assessments reflect the property’s market value. Consequently, the assessor should value the asset using market levels of rent, vacancy, and expenses – not the property’s actual financial results. Just because the subject student housing operator maximizes revenues, for example, doesn’t mean that all of its competitors do.

Consider vacancy: Because of the school calendar, many student housing communities generate the majority of their annual income in a nine-month window and sit nearly vacant over the summer months. That equates to a market-wide effective vacancy of 25 percent. The fact that one complex appeals to summer students does not mean that competing properties should be valued as fully occupied year-round.

Further, unlike most standard apartments, the rent a student housing community can generate is attributable to substantial non-realty components. Most units are furnished, and rent often includes utilities, premium cable television, high-speed internet and other amenities. As a result, the income stream is not exclusively attributable to the real estate, but to personal property, intangibles, and business value as well. Likewise, some developments have favorable contracts with the university whose students will be housed by the community. Such non-realty components are not taxable, and must be removed. Failing to cleanse the income stream solely to its realty component can result in an overstated, overtaxed property value.

Scrutinize comparable sales

In certain markets, evaluating the selling prices for other student housing communities may be a valid method of determining a property’s taxable market value, but assessors often misinterpret that sales data. Just as a property’s income stream reflects more than the value of the real estate, a sales price – usually based on the same income stream – may reflect more than the value of the realty alone.

The most relevant sales for comparison are those where the real estate transacts without any personal property, intangibles, or business value. Since such sales are rare, an assessor using the sales of nearby student housing communities must take care to remove the value of everything but the realty. This task, often overlooked by assessors, requires identifying and measuring hard-to-value assets with certainty.

Moreover, comparable sales have to be adjusted to account for differences between the sold property and the property being assessed. Three communities might all have the same number of beds, but one might have mostly one- and two-bedroom layouts, while another has more community amenities that appeal to a different mix of students. They may serve different schools with different demographics. If the differences between the properties affect their respective rents, then the sales prices should be adjusted accordingly so they best match the configuration of the subject property.

In the absence of sales of purpose-built student housing, some assessors might be tempted to use sales of other types of multifamily housing. Despite superficial similarities, the properties compete in different markets, which appear as structural differences between the properties. An assessor failing to account for such differences may be making a fundamental error.

Cashing in on unusual cases

As the student housing market grows and matures, a particular community may face other circumstances that require a closer look during tax season. For example, public-private partnerships (P3s) are becoming more common in the student housing marketplace. Whether a taxpayer enters a P3 for monetization, development, or operational purposes, the agreement’s characterization can have substantial property tax consequences. Parties to P3s should keep taxability in mind as they draft contracts.

Similarly, in some states dormitories are exempt from property tax because they are deemed educational property. This exemption has historically extended to dormitories owned and operated by colleges and universities. But some properties owned or managed by third parties may still qualify for exemptions because, for example, the school can be deemed the beneficial owner of the property. Of course, the inverse can also be true, so operators should be cautious when drafting contracts so as not to convert an exempt property into a taxable one.

As the student housing market continues to surge, assessors are eager to expand the local tax base by capturing a piece of that growth. But by focusing on the key distinctions of the student housing market, diligent owners can improve the profitability of existing properties and free capital for new investment.

 

 Ben Blair jpgBenjamin Blair is an attorney in the Indianapolis office of the international law firm of Faegre Baker Daniels, LLP, the Indiana and Iowa member of American Property Tax Counsel. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..  

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Apr
17

Solid Base: Proper Lease Structures Can Reduce Property Taxes

In Washington, D.C., as in so many jurisdictions throughout the country, commercial property assessments and taxes have steadily increased for the last five years.  For large office buildings in the District, real estate taxes now constitute an approximately 45 percent slice of the expense pie.  It is not surprising, then, that these tax hikes are generating mounting concern from landlords and tenants, with each side seeking to minimize the impact on the bottom line.

Triple-net leases enable landlords to pass increased property tax expenses to tenants, yet that situation tends to be the exception.  Most office tenants in Washington and other major markets lease space on a full-service basis, so that occupants are typically responsible for increases in real estate taxes only over a pre-established base.

Given this prevailing lease structure, tenants are become increasingly sensitive to how the base is structured.  During the past two years, we’ve noticed a significant uptick in requests from landlords for help with structuring, interpreting and negotiating base years.  The best advice can be summed up as: “Be prepared, be precise and be flexible.”

Be Prepared

Real estate taxes are generally the single largest expense for almost any owner, no matter the state in which the property exists.

During negotiations, landlords should recognize the significance of this cost to the tenant, and assume that the tenant will do the same.  This means that a landlord needs a clear understanding of the property’s current and projected real estate tax situation.

For stabilized properties, current property taxes are a reliable indicator of future taxes, prior to adjustments for changing market conditions.  For new construction or recently renovated properties, however, property taxes can spike in the years following substantial completion.  Understanding a property’s current and likely future assessment will place the landlord in the best possible position during negotiations.

Too often, however, landlords reach out to property tax counsel at the tail end of lease negotiations, after tenants and landlord have already exchanged lease language.  Rather, landlords should consult counsel at the outset of negotiations so that owner and adviser understand the property’s current and projected real estate taxes.

Be Precise

As with any lease clause, precision matters in property tax provisions.  Base-year disputes most often arise when leases use boilerplate language which is either open for interpretation or simply does not apply to the local jurisdiction.  Often this language relies on standard broker/landlord leases and uses generic terms or those that do not clearly apply to the assessing jurisdiction.

Moreover, imprecise language increases the likelihood that costly disputes will arise.  Concerns about base-year language often stalls dispositions or scuttles them altogether.  To minimize the chances of such mishaps, tax-related language should be tailored to the property and jurisdiction.  Again, consulting local property tax counsel is crucial.

Flexibility is Key

There are many ways to negotiate a real estate tax recovery clause.  In the Washington, D.C., metro, standard practice is to set either the first year of the lease or first full calendar year of the lease.  While this standard practice has some superficial logic, it may result in a base year that comprises multiple fiscal years.  For example, Washington’s fiscal year runs from October to September.  As a result, any base year patterned on the calendar year will necessarily require two assessments and could spark a dispute if those assessments differ significantly.

Mindful of this possibility, some landlords and tenants prefer to set base years on the District’s fiscal calendar so that only one assessment will be implicated.  Sometimes, however, the parties are unable to agree on a time period for the base year.  In such cases, taxpayers should shift from a temporal approach to a numeric approach.

For example, if the parties are at loggerheads over whether the base year should be 2016 or 2017, they can simply set a specific assessment or tax amount.  Taking that step can reduce the influence of chance in establishing the base.

Given the outsized importance of real estate taxes to the bottom line, managing these costs is imperative.  While this calls for engaging local counsel to review and appeal the property’s assessment, it should also include working with counsel at the front end to assist in developing appropriate lease language.

cryder scott jpg

Scott B. Cryder is a partner in the law firm of Wilkes Artis Chartered, the DIstrict of Columbia member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys.  He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Mar
20

Pennsylvania Supreme Court Takes Up Issue of Reverse Property Tax Appeals Across State

The Philadelphia School District is looking to increase the number of reverse property tax appeals, which could result in more tax dollars for schools such as South Philadelphia High School

Pennsylvania property owners and tenants, who pay some of the highest property taxes in the nation, are no doubt aware of the annual deadline to file a property tax appeal. After all, one look at a new tax bill is often enough to make even the most seasoned tax manager scramble to contact their local tax counsel.

However, very few taxpayers are aware that the assessment they may have accepted as favorable could easily trigger a reverse appeal filed by the local school district.

Assessment appeals filed by the taxing entities, often referred to as reverse appeals, are increasingly common as cash-strapped school districts seek to fill their coffers. Just as a tax manager might view an inflated assessment as a reason to appeal, more and more school districts see potentially under-assessed properties as a much-needed source of additional revenue.

To the bane of many taxpayers, this tactic has now reached the city of Philadelphia. Despite undergoing a citywide property revaluation for the 2014 tax year, with another currently slated for 2018, the Philadelphia School District recently decided to begin filing reverse appeals against properties it feels are under-assessed.

On Sept. 15, 2016, for the first time, the school district authorized the superintendent to contract with an outside law firm for the sole purpose of filing reverse appeals on the district’s behalf. It also authorized the superintendent to contract with Keystone Realty Advisors LLC, a real estate valuation and advisory group that will serve as the primary identifier of under-assessed properties in the city.

Changes a long time in the making

To many in the world of tax appeals, the emergence of reverse appeals in Philadelphia was unsurprising and inevitable. Keystone had previously peddled its services in a number of other Pennsylvania counties, including Lackawanna and Luzerne. Additionally, last year the Philadelphia School District hired Uri Monson to fill the vacant chief financial officer position. Monson previously served as chief financial officer for Montgomery County, another Pennsylvania county that saw a number of school districts utilize Keystone’s services to identify potential reverse appeals.

In Philadelphia, Monson says the reverse appeal initiative will focus on properties that are undervalued by at least $1 million. City Councilman Allan Domb has indicated that there may be up to $75 million in untapped revenue from commercial properties alone. The school district, which receives 55 percent of the city’s total property tax revenue, stands to gain up to $41 million.

According to Monson, reverse appeals are a tool to ensure that the school district’s funding is spread equitably across all taxpayers throughout the city, and are not intended to target particular neighborhoods or classes of property. Commercial taxpayers are not so sure.

Currently pending at the Pennsylvania Supreme Court is the case of Valley Forge Towers Apartments N, LP vs. Upper Merion Area School District and Keystone Realty Advisors, LLC. At issue before the court is whether the Upper Merion Area School District and Keystone Realty Advisors violated the uniformity clause of the Pennsylvania Constitution by selectively filing reverse appeals on commercial properties, while ignoring significantly under-assessed single-family properties.

The court will have to decide whether a school district’s statutory right to file an appeal, and an economic reason for doing so, insulate the district from review when it decides to appeal an assessment.

The long-term results

The Supreme Court’s decision will likely have far-reaching effects. Should the court decide that the school district and Keystone’s method for selecting reverse appeals does indeed violate the uniformity clause, that finding will likely preclude taxing districts throughout the state, including Philadelphia, from selectively filing reverse appeals.

On the other hand, if the court rules in favor of the school district, it will legitimize the current reverse appeal process that is slowly permeating the state. The latter result may even inspire additional taxing districts to explore reverse appeals as a source of revenue generation.

The court has already received over a dozen friend-of-the-court briefs from various groups with an interest in the outcome, seeking to weigh in on the issue.  Oral arguments were heard on March 8, 2017, though it will be months before the court issues a decision.

Whatever the outcome, taxpayers will want to pay close attention to the Supreme Court’s decision, especially those considering purchasing property in Philadelphia or any other school district that actively pursues reverse appeals.

Under the current system, one of the easiest ways for the districts to pick up on potential appeals is to compare the sale price against the property’s current assessment. Unfortunately, this often means unexpected litigation expenses for new property owners and the potential for higher-than-anticipated tax bills.

Gregory Schaffer photo

Gregory Schaffer is an associate at the Montclair, N.J., las firm Garippa Lotz & Giannuario, a New Jersey and Eastern Pennsulvania member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys.  He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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Feb
01

Putting A Stop To The 'Hidden Property Tax'

When property values rise, tax rates should fall.

Owners should be delighted to see the value of their property increase, but in our current tax environment, higher property values have become synonymous with higher property taxes.

School districts, municipalities, counties and other taxing units have the power to limit property tax bills by lowering their respective tax rates as property values rise. Instead of doing this, however, many taxing entities opt for a tax revenue windfall.

Remarkably, as they collect this additional revenue, these same taxing units claim that they have not raised taxes because they have not increased their tax rate. This distinction has afforded taxing units a convenient escape from the ire of taxpayers. But is it fair?

The Texas property tax system has two components: appraisal districts and taxing authorities. First, appraisal districts assess the market value of taxable property within their boundaries. They then participate in protest hearings initiated by property owners about those values and subsequently certify appraisal rolls for taxing entities.

Second, the governmental bodies that levy and collect taxes prepare budgets and, with their certified appraisal rolls in hand, adopt tax rates sufficient to meet those budgets. Then these municipalities, school districts and other institutions send out tax bills and collect tax revenue.

Both appraisal districts and taxing authorities have the power to affect property owners’ ad valorem tax liability. Nevertheless, many media outlets and news publications have blamed appraisal districts exclusively when tax bills have increased.

For instance, on April 11, 2016, the Austin American-Statesman reported: “Home values rise 9 percent in Travis County!” The San Antonio Express-News reported on May 4, 2016, “2016 Bexar County property value is up $13 billion over year before, real estate values up 7.5 percent.” Similarly, on May 25, 2016, the Dallas Morning News warned about “A taxing problem,” specifically discussing how “Dallas property taxes squeeze middle class” because homeowners in that demographic saw an average increase in the value of their homes of over 11 percent.

These news articles focus on the distress that rising appraised values have inflicted upon taxpayers as property tax bills have increased. Is it fair, though, to malign appraisal districts when they are simply fulfilling their charge to assess property values, especially when they do not participate in the tax rate setting process?

State Sen. Paul Bettencourt (R-Houston), who served as the Harris County tax assessor-collector from 1998 through 2008, formed the Senate Select Committee on Property Tax to look into the issue. The Committee has held public hearings all around the state to listen to taxpayers’ concerns arid frustrations about the system.

It has become apparent that the root of the rising property tax burden lies with tax rates set by taxing units, not in appraised values assessed by appraisal districts. Indeed, at a hearing in Arlington earlier this year, there were hundreds of property owners in the audience, but not one complaint about the Dallas Central Appraisal District or the work of its Chief Appraiser, Ken Nolan.

The issue has caught the attention of a number of politically astute organizations, including the Texas Association of Realtors, which has taken a strong interest in Texas’ property tax policy. Its Director of Legislative Affairs, Daniel Gonzalez, has made it his mission to educate the public about what he describes as the “hidden property tax.” This includes spending resources to maintain the informational website, hiddenpropertytax.com, which provides videos, articles, and other details about the problem.

Likewise, certain taxing entities have spoken out against this “hidden property tax.” The mayor of Fort Worth, Betsy Price, in an opinion piece that appeared in the May 19, 2016 edition of the Fort Worth Star Telegram, wrote: “What to do about high property tax assessments? Cut the tax rate.” The Dallas Morning News echoed this sentiment on May 25, 2016, when it explained, “The only way officials can reduce the burden on taxpayers is by lowering their tax rates.”

And why shouldn’t taxing units do this? Our truth-in-taxation laws are supposed to prevent excessive taxation by limiting tax rate increases that lead to higher tax revenues. The same principle should apply when tax rates remain steady, but through the increase in property values, tax revenues soar. That is an unintended consequence of the prosperity of a community that governments should not be able to exploit.

Texas has one of the nations best property tax systems. To make it work, however, appraisal districts and taxing entities alike must do their part in maintaining the system’s integrity and fairness. Local taxing units should not be allowed to hide behind increased appraised values to raise their budgets, nor should the Texas legislature be able to take advantage of higher appraised values by sending less funding per student to school districts.

Instead of vilifying appraisal districts and complaining about a “broken” property tax system, property owners should put pressure on school districts, cities, counties and other taxing entities to exhibit greater accountability and transparency over tax rates.

daniel smith active at popp hutcheson

Daniel R. Smith serves as general counsel  in the Austin law firm of Popp Hutcheson PLLC, which focuses its practice on property tax disputes and is the Texas member of American Property Tax Counsel (APTC), the national affiliation of property tax attorneys. He represents commercial property owners in property tax appeals across the state, and can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

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